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Friday, April 17, 2009

Ben Shahn Did you hear what they're up to now? August 1938Summer in Columbus, Ohio

Ilargi: Say what you will, but you just can't deny that it does get better by the day. Not the economy of course, but the way that politicians, bankers and reporters manage to embroider time and space warps around daily developments. And it works so far, kind of, so from their point of view, they're probably feeling that it's worth it to contort their minds into unspeakable knots during the day, check up on their Grimm Brothers right before sleep, and come out kicking in the morning ready not just for more of the same, but for doing them all one better. And what can we do but laugh by now?

This morning I woke up to two headlines on the same topic: Citigroup's newly released numbers. Here's Bloomberg's headline: "Citigroup's $1.6 Billion Profit Exceeds Estimates". And then here's Reuters: "Citigroup posts loss, shares rise". Reuters later posted an article called "Citigroup posts smaller loss, shares surge". Did someone complain, perhaps? Even funnier is that Citi shares were down 6% in afternoon trading (Ed. Ilargi: Citi closed own 9%. On the first profit it announced in 5 quarters....). Looking at headlines from other sources, I'd say the split this morning was about 50% for a CIti loss and 50% for a profit.

How crazy is that? Can we assume that these reporters read the same documents, provided we assume they can read at all? How desperate are our news services exactly to produce happy tidings? Did Citi lose money, or did they make some? The best way to answer that question in one sentence: look at the 6% (Ed.:9%) loss in their stock. The longer answer comes from the Bloomberg article, the very same one that claims Citi made a profit. But first of all this warning: a society in which accountants are the most creative people is not one in which you'd like to raise your kids. Here's Bloomberg from the piece that claims the profit side:

Citigroup Inc., the U.S. bank propped up by $45 billion in government bailout funds, ended a five-quarter losing streak by posting a $1.6 billion profit on gains from an accounting rule that helps companies in distress. Profit compared with a net loss of $5.11 billion, or 34 cents, a year earlier, the New York-based bank said in a statement today. The bank posted a loss per share of 18 cents because of payment of preferred dividends.

Right. Citi didn't have a profit. Well, it had a profit, but only if we presume it had no obligations. Sadly, it does. Citi has issued tons of preferred stock lately, and keeping obligations stemming from that off the balance is just Wall (Street) nuts. We'd all be filthy stinking loaded if we'd do our books that way.

But oh boy, does it ever get better now.....

Citigroup posted a $2.5 billion gain because of an accounting change adopted in 2007. Under the rule, companies are allowed to record any declines in the market value of their own debt as an unrealized gain. The rule reflects the possibility that a company could buy back its own debt at a discount , which under traditional accounting methods would result in a profit. Critics say a company in distress is unlikely to realize the gains, and would have to reverse them eventually if it recovers.

What? Citi's profit comes from the fact that it COULD, not DID, buy back the debt it has issued and which has lost much of its value since, an action that CAN be counted as profit even if no debt was actually bought back? A paper profit that owes its "existence" to the fact that a company is sweeping the bottom of the sewer, and potentially gets bigger as the company does worse? (I know that's a bit painting in broad strokes of black and white, but it IS the principle.

The government support and additional capital probably are enough "for now" to spare existing shareholders from being wiped out completely, David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote in an April 9 note to investors. "For prospective new investors, it may be too early to dive in.....

Citi received $45 billion in government support, and still needs silly accounting tricks. The shareholders will be wiped out eventually, no matter what additional funds Washington hands over. Too early to dive in? You be the judge. To be well prepared, you might want to take a look at this tidbit:

The bank still faces speculation about its survival prospects, as reflected in the elevated prices for its credit- default swaps [..] Citigroup’s credit-default swaps as of yesterday were trading at 557, up from 193 at the end of last year. By comparison, rival New York-based bank JPMorgan Chase & Co.’s swaps are trading at 174. Lehman Brothers Holdings Inc.’s swaps were at 322 a week before the U.S. securities firm filed for bankruptcy last September.

Translation: Derivatives traders say very clearly that Citi equals disaster territory, that they expect to burn to the ground any moment now. Wall Street banks are presently pulling winning numbers out of a hat filled with long deceased toxic rabbits, and the theater can go on as long as no-one cares to check the contents of that hat, which by the way is the task of the government. Yeah, right.

Three more pawns from the Lower Manhattan - Capitol Hill revolving doors were caught with stinky fingers in the sticky jar, and who still believes they will be held to account? Obama's car chief Steve Rattner, AIG honcho Ed Liddy and Senator Chris Dodd would all, in a functioning democracy, be temporarily relieved from their obligations pending a thorough independent investigation. We can see what it's all come to when we realize that if such investigations were to seriously take place, none of us could name enough people left to run the country, or the financial system. The Federal Reserve gets away with hiding information on $2 trillion on public money spent on propping up faceless financial institutions by declaring that the New York Fed has no obligation to tell the public anything about what it does with the nation's cash.

The Fed's next step will be to spend more, much more, on the next TARP stage, which will serve to make whole the megalomaniacs who developed the fast depleting shopping malls that more than anything show America's lack of taste and culture. In the process, Bernanke and co. will bring down and take over hundreds upon hundreds of regional banks, driving the financial consolidation process onwards to its long foreseen end goal, where every lender in every town and county is owned by the same small cabal that runs the Treasury department.

And if you think that you are, and will be, able to see the danger signs when the time comes, please do not forget that the Wall Street banks who own more of your town, your country and your world as every single day passes, have no problem coming up with numbers that show they are profitable, while in reality they're losing more money every single hour than you can ever hope to make in a lifetime. And that you are covering their losses. And the only reason you haven't heard the croupier say "Rien Ne Va Plus" is that you still have money left on the table. They want that too.

NOTE: If you really must, you can hear me blab incoherently in my first, and very possibly last, radio interview at Alex Smith's Ecoshock.

The Obama administration’s plan to fix the U.S. banking system is destined to fail because the programs have been designed to help Wall Street rather than create a viable financial system, Nobel Prize-winning economist Joseph Stiglitz said. "All the ingredients they have so far are weak, and there are several missing ingredients," Stiglitz said in an interview. The people who designed the plans are "either in the pocket of the banks or they’re incompetent." The Troubled Asset Relief Program, or TARP, isn’t large enough to recapitalize the banking system, and the administration hasn’t been direct in addressing that shortfall, he said. Stiglitz said there are conflicts of interest at the White House because some of Obama’s advisers have close ties to Wall Street.

"We don’t have enough money, they don’t want to go back to Congress, and they don’t want to do it in an open way and they don’t want to get control" of the banks, a set of constraints that will guarantee failure, Stiglitz said. The return to taxpayers from the TARP is as low as 25 cents on the dollar, he said. "The bank restructuring has been an absolute mess." Rather than continually buying small stakes in banks, weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said.

Stiglitz, 66, won the Nobel in 2001 for showing that markets are inefficient when all parties in a transaction don’t have equal access to critical information, which is most of the time. His work is cited in more economic papers than that of any of his peers, according to a February ranking by Research Papers in Economics, an international database. The Public-Private Investment Program, PPIP, designed to buy bad assets from banks, "is a really bad program," Stiglitz said. It won’t accomplish the administration’s goal of establishing a price for illiquid assets clogging banks’ balance sheets, and instead will enrich investors while sticking taxpayers with huge losses. "You’re really bailing out the shareholders and the bondholders," he said. "Some of the people likely to be involved in this, like Pimco, are big bondholders," he said, referring to Pacific Investment Management Co., a bond investment firm in Newport Beach, California.

Stiglitz said taxpayer losses are likely to be much larger than bank profits from the PPIP program even though Federal Deposit Insurance Corp. Chairman Sheila Bair has said the agency expects no losses. "The statement from Sheila Bair that there’s no risk is absurd," he said, because losses from the PPIP will be borne by the FDIC, which is funded by member banks. "We’re going to be asking all the banks, including presumably some healthy banks, to pay for the losses of the bad banks," Stiglitz said. "It’s a real redistribution and a tax on all American savers." Stiglitz was also concerned about the links between White House advisers and Wall Street. Hedge fund D.E. Shaw & Co. paid National Economic Council Director Lawrence Summers, a managing director of the firm, more than $5 million in salary and other compensation in the 16 months before he joined the administration. Treasury Secretary Timothy Geithner was president of the New York Federal Reserve Bank.

"America has had a revolving door. People go from Wall Street to Treasury and back to Wall Street," he said. "Even if there is no quid pro quo, that is not the issue. The issue is the mindset." Stiglitz was head of the White House’s Council of Economic Advisers under President Bill Clinton before serving from 1997 to 2000 as chief economist at the World Bank. He resigned from that post in 2000 after repeatedly clashing with the White House over economic policies it supported at the International Monetary Fund. He is now a professor at Columbia University. Stiglitz was also critical of Obama’s other economic rescue programs. He called the $787 billion stimulus program necessary but "flawed" because too much spending comes after 2009, and because it devotes too much of the money to tax cuts "which aren’t likely to work very effectively." "It’s really a peculiar policy, I think," he said.

The $75 billion mortgage relief program, meanwhile, doesn’t do enough to help Americans who can’t afford to make their monthly payments, he said. It doesn’t reduce principal, doesn’t make changes in bankruptcy law that would help people work out debts, and doesn’t change the incentive to simply stop making payments once a mortgage is greater than the value of a house. Stiglitz said the Fed, while it’s done almost all it can to bring the country back from the worst recession since 1982, can’t revive the economy on its own. Relying on low interest rates to help put a floor under housing prices is a variation on the policies that created the housing bubble in the first place, Stiglitz said. "This is a strategy trying to recreate that bubble," he said. "That’s not likely to provide a long run solution. It’s a solution that says let’s kick the can down the road a little bit." While the strategy might put a floor under housing prices, it won’t do anything to speed the recovery, he said. "It’s a recipe for Japanese-style malaise."

To the cynical observer, the history of government policymaking might also be called a chronicle of unintended consequences. Take one classic example, detailed in The Concise Encyclopedia of Economics. In an effort to protect its pastoral vistas, Vermont in 1968 enacted a statewide ban on roadside billboards and large signs. Not long after, big and bizarre "sculptures" started appearing adjacent to businesses, including a "twelve-foot, sixteen-ton gorilla, clutching a real Volkswagen Beetle," commissioned by a car dealer, and "a nineteen-foot genie holding aloft a rolled carpet as he emerges from a smoking teapot" on the grounds of a carpet store.

Recent reports highlight other instances of good intentions gone bad. In this month's The Nation, for example, DC editor Christopher Hayes reveals how an obscure tax provision, intended to reduce America's dependence on fossil fuels, has spurred paper makers to add diesel fuel to a process that requires none so that they can qualify for a government subsidy -- worth up to $8 billion this year to the 10 largest companies in the sector. Likewise, a story published earlier this week by the Associated Press notes that "as drought forces families in the West to shorten their showers and let their lawns turn brown, two Depression-era government programs have been paying some of the nation's biggest farms hundreds of millions of dollars to grow water-thirsty crops in what was once desert."

To some, the fact that credit conditions have hardly improved after myriad "bailouts" and "rescues" also reflects the law of unintended consequences. Even though lenders have received more than $211 billion in federal funding to help open up the credit spigots, writes the Washington Post, Treasury Department data indicates that "lending by the nation's largest banks fell six percent in February from the previous month, continuing a downward trend that began in October with the financial crisis." Then again, some might point to other developments this past week and wonder what lawmakers really meant to accomplish by their efforts to return things to "normal."

Last Thursday, for example, Wells Fargo, the nation's second-biggest home lender, reported a record profit for the first quarter that beat the most optimistic Wall Street estimates, according to Bloomberg (albeit with the aid of "cookie jar reserves" and other accounting maneuvers, notes Jonathan Weil, a columnist for the news service, in a later commentary). Then on Monday, Goldman Sachs announced better-than-expected results for its latest quarter (again, not without a measure of assistance from a change in its fiscal calendar, detailed in a blog post by The New York Times' Floyd Norris.) As it happens, the results were good enough to allow the investment-turned-commercial bank to bring a $5 billion stock offering to market.

Finally, this morning J.P. Morgan also delivered surprisingly strong profits for the three-month period just ended, with earnings-per-share that handily topped analysts' estimates. As the Wall Street Journal wrote in a follow-up report, the nation's largest bank was the third big financial institution "to surprise Wall Street with solid results despite the recession." Naturally, some might wonder whether all the good news coming from the banking sector lately is merely an unintended consequence of efforts to get liquidity flowing through the economy again. On the other hand, more jaded types might draw attention to the incestuous and longstanding relationship that the moneyed interests have had with those who are making and implementing policy -- and doling out taxpayer funds like candy to the firms that helped get us here. Intended consequences, anyone?

Citigroup Inc on Thursday posted a first-quarter loss, reflecting a large amount of writedowns and credit losses, as well as the impact of preferred dividends paid to the U.S. government. The company posted a net loss available to common shareholders of $966 million, or 18 cents per share, compared with a net loss of $5.19 billion, or $1.03, a year earlier. Citigroup had lost $37.5 billion in the previous five quarters, largely from exposure to housing-related and complex debt. Analysts on average forecast a loss of 30 cents per share, according to Reuters Estimates, although it was not immediately clear whether the figures were comparable. Citi shares were up 16.5 percent in premarket, electronic trading.The following is reaction from industry analysts and investors:

MANOJ LADWA, SENIOR TRADER, ETX CAPITAL, LONDON"On the surface, Citigroup's first quarter results look good -- they reported earning per share better than analysts expected. But after five consecutive losing quarters, it's difficult to see the current figures as anything more than a blip, especially when it's largely due to an accounting rule benefiting companies in distress. Increasing defaults on home and credit card loans and an outflow of funds from their wealth management business does not bode well for coming quarters."

ANDREW BELL, HEAD OF RESEARCH, RENSBURG SHEPPARDS, LONDON"So far the earnings numbers have been reassuring. We probably have turned the corner in terms of sentiment because with the passage of time, more of the process of repair for the economy is taking place. "The two things worry me. One, the tactical risk from the earnings season or the economy producing a negative surprise and catching the market off balance and the second would be that a recovery in the markets makes policy makers complacent that they have done enough and they don't need anything more to stimulate the economy. That would be premature."

RICHARD HUNTER, HEAD OF UK EQUITIES AT HARGREAVES LANDSDOWN, LONDON"The fact that all of these (banks) have had such a strong first quarter has led to some tentative hopes that perhaps the banking sector crisis is bottoming."

MICHAEL HOLLAND, FOUNDER, HOLLAND & CO, NEW YORK"It was slightly better than anticipated, but we probably underestimated how much government support would be a wind at their back. There's no doubt the challenges are still enormous for Citigroup. If you put it in the context of what we heard from JPMorgan yesterday with its continuing concerns about the consumer, Citi is going to suffer, too. And Citi is heading into this from a weaker position."

Citigroup Inc., the U.S. bank propped up by $45 billion in government bailout funds, ended a five-quarter losing streak by posting a $1.6 billion profit on gains from an accounting rule that helps companies in distress. Profit compared with a net loss of $5.11 billion, or 34 cents, a year earlier, the New York-based bank said in a statement today. The bank posted a loss per share of 18 cents because of payment of preferred dividends. The average estimate of 13 analysts surveyed by Bloomberg was a loss of 32 cents. Citigroup investors hadn’t seen a profit since before Chief Executive Officer Vikram Pandit took over in 2007. While the bank cut compensation costs and other expenses, it couldn’t halt rising delinquencies on home and credit-card loans.

"It’s very hard for me to foresee that one quarterly earnings report, or one announcement by Vikram Pandit that they are more profitable than they’ve been since the third quarter of ‘07, means all past things are forgiven," said Douglas Ciocca, a portfolio manager at Renaissance Financial Corp. in Leawood, Kansas. "There has to be demonstration of traction."Citigroup posted a $2.5 billion gain because of an accounting change adopted in 2007. Under the rule, companies are allowed to record any declines in the market value of their own debt as an unrealized gain. The rule reflects the possibility that a company could buy back its own debt at a discount, which under traditional accounting methods would result in a profit. Critics say a company in distress is unlikely to realize the gains, and would have to reverse them eventually if it recovers. Such reversals probably contributed to a first-quarter loss at New York-based Morgan Stanley, the Wall Street Journal reported April 8.

Citigroup, one of 19 U.S. banks gearing up for the release of "stress tests" run by the Federal Reserve, has quadrupled on the New York Stock Exchange since falling to an all-time low of $1.02 on March 5, in the wake of the company’s announcement that as much as $52.5 billion of preferred stock would be exchanged for common shares to bolster the bank’s equity base. Under that plan, as much as $25 billion of the government’s investment in the bank will be converted into regular shares, giving it a 36 percent voting stake. Citigroup’s tangible common equity -- a cushion against losses that many investors and analysts study -- will increase to $81 billion from about $30 billion, the bank says. Existing shareholders will be left with about a fourth of their original stakes.

The government support and additional capital probably are enough "for now" to spare existing shareholders from being wiped out completely, David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, wrote in an April 9 note to investors. "For prospective new investors, it may be too early to dive in, given continued high-risk exposures that may well require more dilutive actions," Trone wrote. The stock closed at $4.01 yesterday. At its peak in late 2006, Citigroup stock was worth $56.41, for a market value of $277 billion. At the current price, the market value stands at about $22 billion. In November, Pandit, 52, pledged to cut 52,000 jobs from the company’s 352,000-employee workforce, including 26,000 through business divestitures.

In January Pandit reorganized Citigroup, tagging the CitiFinancial consumer-finance and Primerica insurance units for eventual disposal and putting them into a separate division, Citi Holdings, with other businesses deemed "non-core." The move, he said, would help investors focus on the earnings power of the company’s "core" retail, corporate and investment- banking businesses. He also shifted some of Citigroup’s distressed trading securities into a long-term "held-to-maturity" investment status, sheltering them from further writedowns while betting the debt instruments will eventually pay off. The bank still faces speculation about its survival prospects, as reflected in the elevated prices for its credit- default swaps, a type of instrument that investors use to insure against a debt default.

Citigroup’s credit-default swaps as of yesterday were trading at 557, up from 193 at the end of last year. By comparison, rival New York-based bank JPMorgan Chase & Co.’s swaps are trading at 174. Lehman Brothers Holdings Inc.’s swaps were at 322 a week before the U.S. securities firm filed for bankruptcy last September. Retaining top employees may be a challenge for Pandit, Oppenheimer & Co. analyst Chris Kotowski wrote in an April 8 report. "With Citi’s stock permanently diluted and the company deeply dependent on government assistance, we think it is among the most vulnerable to a flight of revenue-producing talent," Kotowski wrote. The receipt of taxpayer money has forced Pandit to endure congressional scrutiny of line-item expenses, including a $10 million executive-suite renovation and a 20-year, $400 million sponsorship of the New York Mets’ stadium in the New York City borough of Queens.

He vowed to cut his salary to $1 until the bank returns to profitability. The earnings report follows earnings announcements by U.S. banks whose results have surpassed analysts’ forecasts. Goldman Sachs Group Inc. on March 13 reported better-than- expected earnings as a surge in trading revenue outweighed asset writedowns. Wells Fargo & Co., the second-biggest U.S. home lender, said last week it had about $3 billion in first-quarter net income, up from $2 billion a year earlier. Profit of about 55 cents a share was more than double the average estimate of analysts in a Bloomberg survey.

Citigroup's health is slowly improving, but the bank's owners are stuck paying for its costly rehabilitation. The New York-based financial giant returned to the black Friday after five quarterly losses, saying it swung to a $1.6 billion profit. Citi cited stronger trading results and a 23% drop in operating costs, driven by 13,000 job cuts during the latest quarter. But common shareholders, who are the ultimate owners of the struggling bank, are still waiting to enjoy the fruits of CEO Vikram Pandit's turnaround push.That's because as accounting rules dictate, Citi calculated its profit before deducting the costs related to preferred shares. The bank has issued these in droves in recent years, to the government and private investors alike, in a bid to bolster its capital cushion against souring loans and trading bets gone bad.

Paying for the preferred shares has gotten expensive, as a look at Friday's earnings statement shows. In the first quarter alone, Citi paid out $1.2 billion in preferred stock dividends. It also took a $1.3 billion hit when the price on some convertible preferred shares it sold in January 2008 reset. Those costs come out of common shareholders' pockets - which is why the bank ended up posting a loss of 18 cents a share in a quarter that was otherwise profitable. The unusual split - a profit for the bank but a loss for the shareholders - highlights the cost of the blizzard of preferred stock Citi has issued since Pandit took over at the end of 2007.

In his first two months at the bank's helm, Citi issued $30 billion in preferred shares to private investors around the globe. Since last fall, the bank has issued an additional $45 billion of preferred stock to the government. Despite the huge sums raised by Citi via the preferred share sales, investors have continued to fret about the health of the bank's balance sheet as real estate prices tumble and more consumers fall behind on their auto and credit card payments. In hopes of quelling worries about the bank's capital and ending talk of nationalization, the government announced a plan in February to convert the bulk of Citi's preferred shares to common shares.

Citigroup Inc. delayed the conversion of as much as $52.5 billion in preferred shares until after the U.S. government completes its so-called stress test of the health of banks. Citigroup said in a statement today that it was making progress on meeting regulatory requirements to proceed with the conversion and left the terms unchanged. The Federal Reserve and other regulators aim to release the results of stress tests on the 19 biggest U.S. banks on May 4, a central bank official who declined to be identified said yesterday. The New York-based lender had previously expected to win regulatory approval to complete the deal by early April.

The delay may exacerbate losses among hedge funds and speculators who bought preferred shares and sold short common stock with the hope of exploiting the difference in prices between the two securities. Citigroup stock has almost tripled since Feb. 27, when the exchange offer was announced, making the arbitrage strategy more costly. "This has caused huge mark-to-market losses for investors who initiated the trade shortly after the deal announcement," Sveinn Palsson, a derivatives strategist at Credit Suisse Group AG in New York, wrote in an April 16 report to clients. Citigroup shares rose 16 percent to $4.65 at 7:11 a.m. in New York after the bank reported a smaller per-share loss than analysts estimated for the first quarter. The stock has advanced since February as investors who sold shares short to finance their purchase of the preferred securities unwound the trade.

Under terms of the deal, the company will swap as much as $27.5 billion of its preferred securities at a conversion price of $3.25 a share. The U.S. Treasury will convert as much as $25 billion of preferred shares, gaining a 36 percent stake in Citigroup. The exchange is part of the U.S. government’s third attempt to shore up Citigroup, which has been battered by $88.3 billion in credit losses and provisions for bad loans since the start of 2007. The conversion would help Citigroup save money on preferred dividends and increase its tangible common equity, a measure of the bank’s ability to absorb losses. Citigroup today ended a five-quarter losing streak by posting a $1.6 billion profit on gains from an accounting rule that helps companies in distress.

JPMorgan Chase and Goldman Sachs Group racked up billions of dollars in trading profits in a volatile first quarter -- but don't expect these lucrative markets to last into the next quarter, or to necessarily benefit other banks, analysts say. Goldman and JPMorgan, seen as probable long-term survivors amid the carnage that ravaged most of the industry, boosted their trading risk levels in the first three months of the year to exploit swings in asset prices. They both expanded market share following Lehman Brothers' demise in September and Bank of America capture of Merrill Lynch. Citigroup, another major competitor in past years and under intense scrutiny following a government rescue, will see whether its hobbled financials significantly weakened its trading business when it reports quarterly results on Friday.

But trading profits and market-share gains may not be so easy to come by in the second quarter, analysts caution, and it may be too late for other banks like Morgan Stanley -- which reports next Wednesday -- to catch up. "This is about the best it's going to get," said Paul Miller, analyst with FBR Capital Markets. "A lot of good things happened in the first quarter," added Miller, noting the pick up in debt and equity issuance after capital markets stagnated at the end of last year. JPMorgan's results benefited from debt underwriting in particular, where it finished second in global rankings for quarterly issuance, followed by Citigroup, Bank of America, Morgan Stanley and Goldman -- in third, fifth, seventh and ninth places, respectively.

For global equity issuance, JPMorgan was again second, followed by Bank of America, with Morgan Stanley, Citigroup and Goldman Sachs in fourth, sixth and eighth places. In addition, the first-quarter mortgage refinancing push led by the U.S. government helped JPMorgan and Wells Fargo, Miller said, and it may have helped other commercial banks including Citi and Bank of America. But the rush from consumers refinancing mortgages, or from companies raising capital, may slow in the second quarter. "We are not projecting this quarter's out performance to be sustained for several more quarters," said Michael Wong, analyst at Morningstar Inc. Some indications are that volatility is abating -- the Chicago Board Options Exchange's VIX volatility index has fallen for its third straight day -- and credit spreads may be easing. These shifts could mean less trading opportunities for JPMorgan and Goldman Sachs.

Even if markets fluctuate further, JPMorgan and Goldman Sachs's first-quarter trading revenue of $6.96 billion and $7.15 billion (4.8 billion pounds), respectively, could still be under threat if competition heats up. "Everyone knows this is the business line that outperformed this quarter," said Wong, adding that as other firms jump onto the bandwagon, there will be more competition for trades and underwriting fees. Boutique banks have been hiring and expanding into trading as larger banks have trimmed staff in a bid to cut costs. Aladdin Capital, a $15 billion Stamford, Connecticut-based money manager, said on Tuesday it is launching a debt capital markets group.

Investors' focus for the next week will be on whether Morgan Stanley and Bank of America -- which combined its investment banking unit with Merrill's in January -- have also managed to profit from volatile markets. "It does put a good deal of pressure on Morgan Stanley and the Bank of America unit to have and be able to report strong results," said George Ball, chairman of investment firm the Sanders Morris Harris Group in Houston. "If they do not they will be badly compromised," Ball added. One of the two last surviving investment banks, Morgan Stanley became a bank holding company along with Goldman Sachs last fall, but it has struggled more than Goldman under losses from complex debt securities and leveraged loans.

Bank of America is also battling mounting losses at Merrill Lynch as well as its own credit card and mortgage units. While in general the trading profits from JPMorgan and Goldman indicate that other investment banking units may have prospered, the caveat is that other banks do not have the capital to support the same volume and scale of trading activity as Goldman and JPMorgan. "JPMorgan and Goldman have some of the best balance sheets in the industry, we can see they benefited from that," said Wong, adding, "Morgan Stanley is not as strong as JPMorgan and Goldman, so they may not have benefited to the extent that JPMorgan and Goldman Sachs did in this environment."

It used to be the most respected investment bank in the world. Now it seems to be a part of more conspiracy theories than the Central Intelligence Agency. Goldman Sachs reported a $1.8 billion quarterly profit this week, and sold $5 billion in new stock at a triple-digit share price. It appears to have weathered the financial crisis as well or better than any of its competitors. It made money on mortgages when the making was good, and somehow got out before the explosion devastated its competitors. Unlike many of them, it appears to have had effective risk-management systems. It says it spent $100 million buying protection against something that seemed ridiculously unlikely at the time — a default of the American International Group.

Yet its denial that it profited from the government’s bailout of the insurance giant is greeted with scorn. People may not be sure about just what Goldman did that was improper, but many seem to think there must have been something. Why is this happening? David A. Viniar, Goldman’s chief financial officer, sounded bewildered when I asked him that. "We are so careful in what we try to do. We are so careful about compliance and following rules, and doing all the things we should do," he said. "I read the stories and I scratch my head."

Let me try to help. Goldman’s explanations sometimes do not ring true, even if they are. When it announced its profits this week, it buried an important fact in the tables on page 10 of a news release, and did not mention it in the text of the release. That fact was that Goldman had lost a lot of money in December, which would have been part of the quarter had the firm not changed its fiscal year. As a result, that loss does not show up in any quarterly number. Goldman won’t say if a December-to-February quarter would have been profitable. Was Goldman’s disclosure misleading? Legally, no. There was full disclosure. But the existence of the orphan month, with its big loss, was largely overlooked in the initial news stories. When it was reported later, Goldman was left looking as if it had tried to pull a fast one.

Something similar happened with regard to Goldman’s relations with A.I.G., which owed Goldman a lot of money that it was able to recover thanks to the bailout. Mr. Viniar says that Goldman was fully protected if A.I.G. did default, and that A.I.G.’s bailout had little if any effect on Goldman’s earnings. When I talked to Mr. Viniar, he conceded to me, as he had to others, the obvious fact that Goldman would have been affected if an A.I.G. collapse had led to a systemic failure. But Goldman has not emphasized that, and at times has seemed to be denying it, as when it said that collateral put up by other firms would have protected it if those firms had collapsed as a result of A.I.G.’s failure.

Then there is the matter of the $10 billion government investment under the TARP program. Goldman has proclaimed that it wants to pay it back, and get out from government control of things like bonus payments. But it did not mention the $28 billion it has borrowed with a guarantee from the government’s Federal Deposit Insurance Corporation, a guarantee that is worth a lot to Goldman. Mr. Viniar told me Goldman expected to borrow more, probably hitting the maximum $35 billion. He sees no contradiction in that. Wall Street competitors, speaking privately and perhaps simply showing they are jealous, see it as hypocritical.

Goldman’s aura goes back at least a generation. When I was in business school in the early 1980s, getting a job there was viewed as the ultimate accomplishment. It should be no surprise that a firm that often got first choice in hiring ended up with some very good people. Nor should anyone be surprised by the jealousy and resentment Goldman has aroused, especially when it seemed to be willing to trade aggressively to exploit others’ weaknesses. The belief that Goldman has a pipeline to the administration in Washington — whichever administration that might be — has been around for a long time. But it took on far more importance last year as government officials, often Goldman alumni, gained the power to decide which firms lived or died.

Once again, Goldman people seem shellshocked. "I’ve read the ‘Government Sachs’ articles," Mr. Viniar told me, adding that he thought public service was to be encouraged, not rebuked. "For people to write stories that they were there to help Goldman Sachs is offensive." It is an offense that began with Goldman’s competitors, who coined and popularized the term. Such carping has a long pedigree. Back in 1998, the troubled Russian government was able to borrow $1.25 billion in the international capital markets at a time when it was having great difficulties meeting its domestic obligations. I recall asking one money manager why he put up some of the money, given Russia’s obvious problems. There was, he assured me, no real risk.

The Russian bonds were underwritten by Goldman, which would not have gotten involved without getting an assurance from Robert Rubin, the former Goldman chief executive who was then President Clinton’s Treasury secretary, that the American government would step up if needed to prevent a Russian default. It was as tidy a conspiracy theory as the current one that asserts A.I.G. was bailed out, and Lehman Brothers was allowed to fail, because that was what Goldman wanted. After all, Henry M. Paulson Jr., another former Goldman chief executive, was President Bush’s Treasury secretary. The 1998 theory turned out to be wrong. Russia did default, and the bondholders lost money. Goldman itself, however, escaped unscathed.

As would happen nearly a decade later with mortgage securitizations sold by Goldman, by the time the Russian debt defaulted, the firm had reversed its exposure and may have even been in a position to profit from the default. Part of Goldman’s problem now is that there is confusion as to whether the bank bailouts are the corporate equivalent of welfare checks or Social Security benefits. If they were simply aimed at invigorating the financial system, with the money going to banks that could use it to increase lending, then there logically should be no public outrage at bonuses for executives of healthy financial institutions. No one is offended to see a wealthy Social Security recipient embarking on a luxury cruise.

But there is a big difference if these are seen as bailouts for the undeserving rich. If you don’t like buying coffee for a beggar, how about Champagne? Unfortunately for Goldman and other banks, the public has decided TARP is welfare. "It’s become a scarlet letter," Jamie Dimon, the chief executive of JPMorgan Chase, said Thursday as he announced his own bank’s $2.1 billion quarterly profit. This is hardly the first time that outrage over welfare payments stretched the facts. Sixty years ago, A. J. Liebling, then the press critic of The New Yorker, wrote a hilarious piece about how the New York newspapers had gone crazy over a "Lady in Mink" who was collecting welfare benefits. The eventual discovery that the coat was, in Mr. Liebling’s words, "rather mangy," and that she deserved the money, received less attention.

Goldman appears to be prospering now, while its competitors struggle and the rest of the world endures a recession caused in no small part by Wall Street excesses. The firm has every right to try to get out from under rules that could limit bonuses, and to give nice raises to the employees it did not lay off. It deserves to feel proud that its risk management systems worked while others failed. But it should not expect such success to bring popularity. Misery loves company, and there would be no little joy on Wall Street if Goldman, having paid back the TARP money, was forced by some new crisis to go to Washington, hat in hand, asking for the money again.

Analysts see several reasons why the recent strong earnings reports by the likes of Wells Fargo and Goldman Sachs may not be repeated. A few months ago, a teetering U.S. banking system seemed ready to take down the global economy. Now the stocks of the biggest banks have been on a tear, following rosy earnings announcements by Wells Fargo and Goldman Sachs. But the strong first-quarter numbers may not be as strong an omen as they seem. Analysts expect a good chunk of the industry's gains to prove fleeting, leaving banks to grapple with the grim economy and investors to deal with stock market fallout. "Bank earnings benefit from a number of things that don't have a lot to do with fundamentals," says Fred Cannon, chief equity strategist at investment bank Keefe, Bruyette & Woods (KBW). Consider the refinancing boom, which was triggered by record-low mortgage rates. The flurry of activity helped propel Wells to a $3 billion gain this quarter and will likely boost other banks as well. But the trend may quickly peter out since there's a limited pool of people who can refinance their loans. Among the borrowers who don't typically qualify: the one in five owners who are underwater on their mortgages, meaning their homes are worth less than their loans.

The record-low rates are goosing bank earnings in other ways. Many banks service the mortgages in large investment pools, collecting homeowners' monthly payments and distributing them to investors. The value of those servicing contracts go up and down, and banks buy securities to hedge against those movements. When rates fall, the securities can rise in value, often faster than the banks mark down the value of the contracts. In those cases, banks book profits. That mismatch, says Ed Najarian, head of bank research for institutional broker ISI Group, probably helped Bank of America (BAC) and Wells in the first quarter. But such gains are hard to repeat. "While [Wells'] mortgage revenue will stay strong at least in the second quarter, they're unlikely to get another hedge gain," Najarian says. A spokeswoman for Wells Fargo, which plans to release more details about its profits on Apr. 22, declined to comment. A spokesman for BofA declined to comment ahead of the bank's Apr. 20 earnings announcement. New accounting rules may have come to the banks' rescue as well. Early in April, banks got the O.K. to use their own judgment in valuing assets, rather than relying on depressed market prices. The result: Banks may have raised the value of their toxic assets in the first quarter, thereby increasing earnings. "You could have paper gains that are offsetting real losses during the period," says Donn Vickrey, co-founder of research firm Gradient Analytics.

Then there's case of Goldman Sachs' missing month. On Apr. 13, the bank reported eye-popping profits of $1.8 billion for the first quarter. Not bad, but Goldman switched to a calendar year from a fiscal one ending Nov. 30. That meant December, and its $780 million loss, was an orphan—omitted from the results for both the full fiscal year of 2008 and the first quarter of 2009. A Goldman spokeswoman said the company was required to switch to a calendar year when it became a bank holding company last fall. Nonetheless, analysts are raising doubts about whether Goldman's profits will persist. The trading unit accounted for much of the gains, while the other groups remain lackluster. "Given the extent to which [Goldman's] earnings was concentrated…coupled with weak economic conditions and capital markets turmoil, we believe it would be premature to conclude that a sustained turnaround is under way," Scott Sprinzen, an analyst at Standard & Poor's (MHP), said in an Apr. 14 report.

Bank earnings aren't entirely flimsy. The growth in customer deposits could prove lasting. Banks can also borrow at close to 0% from the Federal Reserve and lend money at much higher rates, profiting handsomely on the difference. A few firms, including JPMorgan Chase, may take the quarter to increase reserves for bad loans, sacrificing profits to bolster their books. The earnings pop comes in the nick of time: Officials have been putting big banks through their paces, analyzing the results of "stress tests" to gauge how banks will fare in a worsening economy. The prospect of healthy profits may reassure regulators that a bank can replenish its capital, unaided over time. (The U.S. could release details in early May.) Still, banks remain plagued by fundamental uncertainties—chiefly the toxic assets that they have been unable or unwilling to shed. Ultimately, sustainable earnings will depend on the health of the economy. "The economy needs to stabilize," says James Cassel, vice-chairman at investment bank Ladenburg Thalman. "I don't think we've hit the bottom yet."

JPMorgan and Wells Fargo play up an obscure measure of their profitability to show how strong they are - but surging credit losses may hint otherwise.

Just in time for TARP repayment season, the big banks have found a new way to show off their supposedly good health. New York-based JPMorgan Chase became the latest financial giant to beat Wall Street's expectations Thursday, posting a first-quarter profit of $2.1 billion, or 40 cents a share. CEO Jamie Dimon has spent the past year boasting of his bank's "fortress balance sheet," but he shifted gears Thursday, stressing another factor that he said will see JPMorgan through the economic crisis: the underlying earnings power of its core consumer, commercial and investment banking businesses. JPMorgan said its pretax, pre-provision earnings -- reflecting the profits the firm brings in before paying Uncle Sam or taking account of current and future loan losses -- were $13.5 billion in the first quarter.

The bank hasn't previously publicized this figure, which is favored by analysts but isn't recognized under generally accepted accounting principles, in its earnings releases. But JPMorgan isn't the only bank trotting it out. A week ago, for instance, Wells Fargo surprised investors by saying it expected to post a $3 billion profit in its first quarter -- double Wall Street's expectations. Just in case the message wasn't clear, the bank also said in that release that its pretax, pre-provision earnings for the quarter were $9.2 billion. "Business momentum in the quarter reflected strength in our traditional banking businesses, strong capital markets activities, and exceptionally strong mortgage banking results," Wells said last Thursday.

Big bank profits won't make everyone happy, given the uproar in Congress over rising fees and weak loan volumes at financial firms taking federal help over the past year. But with the biggest institutions awaiting the results of federally administered stress tests, due in coming weeks, executives are eager to paint a picture of their institutions as healthy and stable. After all, investors - who have flooded back in to bank shares over the past month - may soon be called on to buy more stock. Analysts are anticipating a flurry of capital-raising among banks once the stress tests end. They expect to see the healthiest institutions following in the footsteps of Goldman Sachs and selling stock en route to an early exit from the Troubled Asset Relief Program.

Weaker banks are expected to try to raise money, with less certain success, to bolster their capital cushions. The good news at JPMorgan and Wells is that the first quarter's pretax, pre-provision profits are -- like the bottom lines the banks reported -- better than analysts were expecting. JPMorgan benefited from a much stronger performance at its investment bank, where revenue more than doubled from a year ago. Wells enjoyed the fruits of a federally engineered mortgage refinancing boom. The bad news is that credit costs -- reflecting the expenses tied to writing off bad loans and reserving for future losses -- are rising and expected to go higher.

JPMorgan said first-quarter credit costs surged 97% from a year ago to $10 billion, including a $4 billion addition to its loan loss reserve. The bank's loan loss reserve stands at 4.5% of total loans -- up from 3.6% at the end of 2008. It's also well above rivals' levels. Yet nonperforming loans rose even faster in the first quarter, with the bank's reserves falling to 241% of nonperforming assets from 260% at year-end. That's why even with all JPMorgan's firepower, Dimon isn't breathing easy. "If the economic environment deteriorates further, which is a distinct possibility, it is reasonable to expect additional negative impact on our market-related businesses, continued higher loan losses and increases to our credit reserves," he said.

Where is the fury now? The populists with pitchforks who screamed bloody murder at the A.I.G. bonuses are not saying nearly enough, or screaming loudly enough, about an even more outrageous action by the recently bankrupt banks that have now had the impudence to hike credit card interest rates sharply, even on customers who have always been current in their payments. The banks have joined together to form an offensive alliance that has, in effect, declared war on the United States, its people, and its economy. An accurate name for this coalition of bankers would be "F U, U & U & F the USA."

Or, more simply, this Bankers Axis of Evil, which includes Citibank, Amex, J.P. Morgan Chase, and Capitol One, could be called by a variant of the name of another of its members, not The Bank of America, but The Banks Against America. We, through the government aid they received, gave them a helping hand; now they give us The Finger. I called Citibank when I saw the increase in my rate. The customer representative said to me, "Oh, that was nothing aimed at you personally; we did it to everyone, because of the bad economy." I burst out laughing. These rate increases--some to as high as 29 percent--are exactly the opposite of what the bad economy needs for recovery. They mean that much larger shares of the income of many people will have to go into interest payments, rather than the new purchases that would help bring the economy back.

These obscene interest rates are the latest in a series of the banks' launches of their Weapons of Mass Depression at the American people and our economy. By these actions, the perpetrators reveal themselves once again to be not bankers, but bankrupters. Through their greed in the past, they brought their banks to the edge of bankruptcy; through their greed in the present, they are pushing many middle-class Americans to the edge of bankruptcy. This is class warfare with a twist. It's not a war between the rich and the poor so much as it is a war by the rich against the middle class. The ridiculous rate increases are probably not even in the selfish interests (the only interests that concern them) of the banks. They are likely to force many more people into bankruptcy and default on their balances.

Their attitude seems to be that if the economy is going to go under, they will go first-class on the Titanic. The Fed effectively lowers the interest rate that banks pay to zero and the banks respond by raising the interest rates they charge to levels that used to be charged only by organized criminals. We can draw the appropriate conclusion about what the organized bankers have become. The criminal loan sharks of the past have been displaced by "legitimate" loan T-rexes of the present. The banks' policy is MAD: Mutually Assured Depression. They must be stopped. NOW. As the American people bail out these bankrupters in their sinking yachts, they throw the water back on us, submerging our lifeboats and drowning us: Soak the middle class. Beat the fingers of those clinging to the sides of the lifeboat.

While Republicans and the Faux News faithful were holding their silly "tea parties" (those who think that spending during a near-depression is a bad idea may also be so deluded that they will think that raising interest rates on consumers in a near-depression is a good idea), the banks have been holding their pee-parties. This is trickle-down with extraordinary vengeance. What's trickling down on us establishes us as peons--or, rather, pee-ons. We, the people, through our taxes, have poured sustenance into the top end of the bandit banks, and they have thanked us releasing excrement on us from the other end. Succor the rich and tell the rest of us to suck on it.

These irresponsible banks tell their responsible customers that an "increase is necessary because times are tough" and that what they euphemistically call "re-pricing" is needed to "reflect current economic conditions." Do they think we are that stupid? Are we? Rise up Americans! Open your windows and shout (or, much better, telephone, email, or write the President, your senators and member of Congress, television and radio stations, your newspapers, blogs--and your friends and neighbors) and shout: "We're mad as hell, and we're not going to take it anymore!" President Obama and Democrats (one would hope a number of Republicans, too) should join together to say to the bankrupters what the first President Bush did to Saddam Hussein after the invasion of Kuwait: "This will not stand!"

Let us insist that laws be enacted that establish a federal usury standard at a reasonable rate and that such rates be made retroactive for all credit card accounts. (There will, of course, be howls about the sanctity of contracts, but the fine print that allows one contractor to change the rules whenever he feels like it and to do to the other essentially whatever the hell he wants to should not be considered a valid contract.) We can call the battle Americans vs. Predators. A federal usury law with real teeth will be tough on South Dakota and Delaware, but they chose to legalize larceny and they have benefitted long enough at the expense of millions of others. As we protect our commerce from seafaring pirates off the African coast, let us also reclaim our country and our economy from these land-based American pirates.

Historian Robert S. McElvaine is Elizabeth Chisholm Professor of Arts & Letters at Millsaps College & author of: The Great Depression: America, 1929-1941 and Down and Out in the Great Depression: Letters from the "Forgotten Man". His latest book is Grand Theft Jesus: The Hijacking of Religion in America.

Federal Reserve Chairman Ben S. Bernanke said the collapse of U.S. lending will probably cause "long-lasting" damage to home prices, household wealth and borrowers’ credit scores."One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be," the Fed chairman said today in remarks prepared for the central bank’s community affairs conference in Washington. "The damage from this turn in the credit cycle -- in terms of lost wealth, lost homes, and blemished credit histories -- is likely to be long-lasting."

The U.S. central bank has cut the benchmark lending rate to as low as zero and taken unprecedented steps to stem the credit crisis through direct support of consumer finance and mortgage lending. The Fed plans to purchase as much as $1.25 trillion in agency mortgage-backed securities this year to support the housing market and is providing financing for securities backed by loans to consumers and small businesses. Bernanke and the Federal Reserve Board approved rules last July to toughen restrictions on mortgages, banning high-cost loans to borrowers with no verified income or assets and curbing penalties for repaying a loan early. The Fed action came after members of Congress and other regulators urged the Fed to use its authority to prevent abusive lending.

"We should not attempt to impose restrictions on credit providers so onerous that they prevent the development of new products and services in the future," Bernanke said. Regulations should ensure "innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes." Bernanke didn’t discuss the outlook for the economy. Central bankers next meet April 28-29. At their March meeting, policy makers said they saw "downside risks as predominating in the near term," according to minutes released April 8.

U.S. taxpayers need to know the risks behind the Federal Reserve’s $2 trillion in lending to financial institutions because the public is now an "involuntary investor" in the nation’s banks, according to a court filing by Bloomberg LP. The Fed refuses to name the borrowers, the amounts of loans or assets banks put up as collateral under 11 programs, arguing that doing so might set off a run by depositors and unsettle shareholders. Bloomberg, the New York-based company majority- owned by Mayor Michael Bloomberg, sued Nov. 7 under the Freedom of Information Act on behalf of its Bloomberg News unit. It made the new filing yesterday. "The Board’s arguments are based on wispy speculation, lack evidentiary support and are contradicted by economic theory," said Thomas Golden and Jared Cohen, lawyers with New York-based Willkie Farr & Gallagher LLP, in a motion asking the judge to require disclosure.

"These government actions, which have been shrouded in secrecy, are at the heart of Bloomberg’s FOIA requests," the attorneys said. Members of Congress also have demanded more information than President Barack Obama and former President George W. Bush have disclosed on the bailout of the U.S. financial industry. Congress approved $700 billion to bolster banks, whose losses on mortgage securities and home loans contributed to the recession. "We’ve all got a stake in how the government is managing this program," said Lucy Dalglish, executive director of the Arlington, Virginia-based Reporters Committee for Freedom of the Press. "The information is definitely something that is within their discretion to disclose."

Fed officials are considering steps to provide the public with more information about emergency programs, people familiar with the matter said April 14. The Federal Reserve, consisting of seven governors in Washington and 12 regional banks, was established in 1913 and charged by Congress with ensuring low inflation, maximum employment and a stable financial system. The largest U.S. banks have tapped more than $125 billion in government aid under the Troubled Asset Relief Program in the past seven months. Bank stocks rose following the announcement of capital injections. Bank of America Corp. and Sterling Financial Corp. have voluntarily disclosed borrowing from the Fed, Bloomberg said in the suit.

The Fed began expanding its lending programs in August 2007 with the Term Discount Window program. The central bank’s loans don’t have oversight requirements or compensation limits that Congress imposed upon the TARP. Assets, including loans and securities, on the Fed balance sheet totaled $2.09 trillion as of April 9. The Fed Board of Governors contends that it is separate from member institutions, including the Federal Reserve Bank of New York, which runs most of the lending programs. Most documents relevant to the Bloomberg suit are at the New York Fed, which isn’t subject to FOIA law, according to the central bank. The Board of Governors has 231 pages of documents, to which it is denying access under an exemption for trade secrets.

"The Board cannot seriously maintain that the NY Fed does not perform governmental functions and control information of interest to the public," Bloomberg said in yesterday’s motion. Banks oppose any release of information because that might signal weakness and spur short-selling or a run by depositors, the Fed argued in its March 4 response. The release of the information "can fuel market speculation and rumors," including a drop in stock price and a run on the bank, the Fed said. Bloomberg replied yesterday that "these speculative injuries relate only to the reactions of customers, shareholders and other members of the public, not to competitors’ use of the borrowers’ proprietary information to their advantage," the exception to disclosure under the FOIA law.

The Fed’s lending is "a strictly temporary measure to create expansionary support in the economy," Fed Chairman Ben S. Bernanke said April 14 in response to questions at Morehouse College in Atlanta. The Fed has "been working very hard to increase our transparency" on lending and operations, Bernanke said. The central bank’s Web site contains "a huge amount of information" on how the lending programs work, he said. On Feb. 23, the Fed began disclosing a breakdown by broad categories for collateral pledged by banks and bond dealers after Congress demanded more transparency. The added disclosure doesn’t identify specific banks or collateral they posted.

Government loans, spending or guarantees to rescue the U.S. financial system total more than $12.8 trillion since the international credit crisis began in August 2007, according to data compiled by Bloomberg as of March 31. The total includes about $2 trillion on the Fed’s balance sheet. The Freedom of Information Act obliges federal agencies to make government documents available to the press and public. The Bloomberg lawsuit, filed in New York, doesn’t seek money damages. The case is Bloomberg LP v. Board of Governors of the Federal Reserve System, 08-CV-9595, U.S. District Court, Southern District of New York (Manhattan).

In its latest attempt to restart financial markets, the Federal Reserve is weighing a twist in one of its rescue programs that it hopes will encourage investors to buy long-term commercial-mortgage-backed securities. The Term Asset-backed Securities Loan Facility, or TALF, offers three-year loans to investors who use them to buy asset-backed securities. Fed officials are considering whether to offer investors in commercial real-estate securities loans of as long as five years to make the program more appealing. But the Fed loans would become less attractive the longer they run to encourage investors to seek other financing as the economy recovers.

Intense behind-the-scenes talks between the Fed and the commercial real-estate industry over the matter are emblematic of the delicate position the central bank is in as it tries to revive markets. Fed officials want to accommodate investors, but fear that if they go too far they could undermine the central bank's longer-run objectives. Officials are worried that making too many long-term loans could interfere with their ability to withdraw credit and raise interest rates when the economy recovers. "In our meetings with the Fed, they said 'we get it' that the five-year term is of paramount importance to CMBS investors," said Christopher Hoeffel, president of Commercial Mortgage Securities Association, a trade group.

People familiar with the matter say Fed officials haven't reached a decision on the matter. Fed officials already reluctantly extended the terms of TALF loans from one year to three years. The Fed's TALF program is aimed at reviving securitization markets, a critical source of credit in a wide range of sectors. In these markets, banks package loans -- from auto loans to commercial real-estate debt -- into securities that are sold in pieces to investors around the world. TALF offers investors cheap, nonrecourse financing to purchase the bonds.

Real-estate markets are a major subset of the securitization industry. And a record amount of commercial real-estate debt is coming due between now and 2012. Delinquency rates on commercial real-estate loans already are rising because rents are falling on commercial properties as vacancies rise. Defaults would likely rise further if borrowers are unable to refinance loans as they become due. The absence of sales is aggravating the problem by driving commercial real-estate values down further. Details of a compromise are still being worked out.

The suddenly red-hot financial sector shrugged off the bankruptcy of No. 2 U.S. mall owner General Growth Properties Inc, but the commercial real estate downturn it signals could haunt U.S. banks -- especially regional ones -- in the months to come. The meltdown in office and other nonresidential properties has already squeezed U.S. financial companies, with banks from Goldman Sachs Group Inc, to Citigroup Inc and insurers from American International Group to MetLife Inc reporting billions in writedowns. But the biggest real estate failure in U.S. history could still foretell greater-than-expected pain ahead for banks in the real estate arena.

"General Growth Properties is basically a message to the rest of the financial world that this is going on, because there are lots of small deals, ones that don't gather the sort of attention that General Growth (has), that are having difficulties," said James Ellman, president of hedge fund Seacliff Capital. General Growth's collapse is unlikely to be the last by a major U.S. developer as most are finding few sources of funding for sales or to refinance maturing debt. About $814 billion of commercial mortgage debt is expected to mature over the next two years, according to real estate research firm Foresight Analytics. "The outlook has worsened," said Anton Schutz, president of Mendon Capital.

In addition, banks could also be forced to renegotiate some loans in order to avoid further losses. "The banks not necessarily want to own the shopping centers. Prices are very low, so the banks may be under pressure to give more leeway to stressed mall operators or shopping centers operators to continue to operate with the hope they can get through the recession rather than seizing the property, selling it at a fire sale price and having to suffer a large loss," Ellman said. Brokerage house Fox-Pitt Kelton estimated that commercial real estate represented in average 23 percent of the loans of the almost 60 banks it covers, with as much as 57 percent in the case of PacWest Bancorp. It said banks still need to record $63 billion in construction and commercial real estate losses, or 83 percent of the estimated total losses in that business.

In addition, Fox-Pitt said regulatory data for the top 100 banks suggested construction and commercial real estate losses were 2.39 percent and delinquencies were 5.27 percent in the fourth quarter, still far below the historical peaks of 4.46 percent, and 17.16 percent, respectively, from the early 1990s, when these loans were the primary source of credit turmoil. Regional banks could be some of the main victims. "They have financed smaller properties in their communities, little malls, or regional centers, and those are certainly getting affected as you are having retailers retrenching ... and obviously the ability for malls to carry their debt service weakens," Schutz said. Fox-Pitt estimated BB&T Corp, Commerce Bancshares Inc and Sterling Bancshares Inc still need to realize between 94 and 95 percent of their construction and commercial real estate portfolio.

Beyond regional banks, even Wall Street stars seem to be in trouble. Earlier this month, Barclays Capital analyst Roger Freeman estimated Morgan Stanley could incur in $2.6 billion losses from its real estate investments. Goldman Sachs and Sanford C. Bernstein cut the Wall Street's bank earnings forecast citing higher writedowns in its commercial mortgage backed securities and its real estate investment portfolios. But their are not alone. Among the largest commercial banks, Fox-Pitt estimated Bank of America Corp's future losses related its construction and commercial real estate portfolio represented 5 percent of its common shareholders equity. "There is a fear that the provisions haven't been fully taken yet," said Thomas Russo, principal at Gardner Russo & Gardner.

Credit default swaps, the derivatives instruments that have figured prominently in the global financial crisis, are now being blamed for playing a role in two bankruptcy filings this week. Bankers and lawyers involved in restructuring efforts say they are concerned some lenders to troubled companies, such as newsprint producer AbitibiBowater and mall owner General Growth Properties, stand to benefit from a default because they also hold default swaps, which entitle them to payments in such events. "We have seen CDS becoming a significant factor" when negotiations on out-of-court restructurings fail, said Alan Kornberg, the partner in charge of the bankruptcy practice at Paul, Weiss, Rifkind, Wharton & Rice, speaking generally. "We used to talk about the practice theoretically but now we see cases where it is hard to get lenders to agree to tender or to compromise and then you find out that these holdouts had significant CDS protection."

AbitibiBowater, which filed for bankruptcy protection yesterday, ran into trouble as the dire state of the newspaper industry eroded its cash flow and left it unable to service its debt load. It sought to persuade debt holders to exchange bonds due in August for new debt with longer dated maturity and higher yields, but failed to do so as creditors squabbled. Such exchange offers require the support of a significant number of lenders, 97 per cent in the case of bondholders in this case. But those who withhold support often have powerful incentives to do so, either because they hope to be made whole or because they are seeking to force a filing that would trigger payments under their credit protection agreements, bankers and lawyers say.

Some creditors, including Citigroup, which held a small exposure to AbitibiBowater, hedged themselves in the CDS market, meaning their economic interest in the deal was different to lenders who had not bought credit insurance, according to people familiar with the matter. Citigroup declined to comment. Lawyers say CDS holdings were also a factor in the default and filing for Chapter 11 protection of General Growth Properties this week. Restructuring advisers expect many more such cases involving so-called fallen angels, or firms originally investment grade, since CDS was widely sold on such names.

There's another big reason -- besides AIG -- that Wall Street trading desks have been booking such fat profits lately: fees they're collecting closing out interest rate swaps that have been exploding in the faces of cities, states, towns and public utilities over the past year. Put another way: they're not just booking those billions soaking the government, they're booking them soaking...the government. Along with hospitals, utilities, park authorities, pretty much every other realm of the public or nonprofit sector... Including Harvard! In December the university raised $2.5 billion dollars in a bond offering partially designed to give them the capital to buy out of $570 million in underwater interest rate swaps it had invested in back in 2005. The swaps were expressly endorsed by then-president Larry Summers, now head of the National Economic Council.

Harvard sold the bonds with the underwriting and advisory services of JP Morgan, Morgan Stanley and Goldman Sachs -- the same group of banks, according to Bloomberg, that endorsed the "Summers swap." Another recommendation: that Harvard offer an interest rate as much as 1.41 percentage points higher than an identically rated corporation would pay to borrow the money to sweeten the deal for investors. (That, if you were wondering, is an example of the unequal credit system perpetuated by the rating agencies differing standards for corporate and public debt that so rankles House Financial Services Chairman -- and Harvard alum -- Barney Frank.) At those terms, money came flowing in to Harvard:

"It was a riot," said John Flahive, a senior vice president at BNY Mellon Wealth Management, of demand for the Dec. 10 bonds. His $1 million buy "was only 20 percent or 25 percent of what I wanted."

And much of it came right back into the coffers of the banks with whom it had entered into its 19 swap contracts -- including Goldman, Morgan Stanley and JP Morgan.

The value of Harvard's swaps dropped as the fixed rates sought by banks in exchange for floating rates on new swaps fell below what the university was paying. By Oct. 30, its swaps were worth a negative $570 million, meaning that's how much Harvard needed to pay to get out of them, S&P said. ...Some proceeds from the $1.5 billion bond sale paid termination fees for the forward-rate swaps, the S&P report said. Harvard declined to say how much it spent to get out of the agreements. As much as $99.3 million of the $1 billion sale paid off swaps related to existing debt, Harvard's official statement on those bonds said.

It's hard to explain exactly how swaps sent so many public sector institutions into such fiscal peril so quickly, except to say that the contracts all hinged on the financial health of a few bond insurers that all went bust in tandem with AIG, and relatively liquid markets that started to collapse with Bear Stearns. But critics have long suspected the swaps were engineered primarily to ensure a steady stream of fees to the banks that arranged the deals -- and last year Ben Bernanke wrote a letter to Congressman Jim Moran suggesting public sector entities might consider banning derivatives in the future. As for Harvard, we're pretty sure their business model is safe. Good thing they got rid of that Summers guy though, huh.

As Senator Chris Dodd fights for his political career, the embattled chairman of the powerful Senate banking committee is receiving his own economic rescue package from the finance industry. According to the five-term senator's latest campaign disclosures, filed earlier this week, the financial sector is flooding Dodd's campaign war chest with donations in advance of what is expected to be a tough reelection bout.

Dodd, who's had a rough year, can certainly use all the support he can get. Last summer, the news broke that he had received two sweetheart loans through subprime lender Countrywide's "V.I.P." program. And in March, Dodd first denied and then later admitted that he had inserted language into the economic stimulus bill that would allow AIG executives to keep their bonuses. Amid accusations that he has grown too chummy with the industries he oversees as head of the banking committee, Dodd has seen challengers to his 2010 reelection crop up on his left and his right. Recent polls show him with a popularity rating of just 33 percent in Connecticut, losing in hypothetical match-ups with three different Republicans. Political handicappers consider him the most vulnerable Democratic incumbent in the Senate; the GOP is raring to pick him off.

Despite his waning appeal in Connecticut, Dodd's fundraising effort picked up steam in the first three months of 2009. He raised just more than $1 million during the quarter, according to federal campaign disclosure records. Almost a third of that money—at least $299,000—came from banking and investment executives, financial industry trade groups, and finance-oriented political action committees (PACs). An additional $68,000 came from lobbyists, many with clients on Wall Street. And that doesn't count the formidable financial support Dodd has received from insurance and health care interests. It's not unusual for the chairman of an influential committee to haul in loads of campaign cash from the businesses that are within his committee's jurisdiction. But with his future in the Senate in jeopardy, Dodd truly has to rely on his supporters in the industries he oversees, all while presiding over key components of the various financial bailouts currently underway. That is, he's pushing the envelope when it comes to Washington's pay-to-play routine.

Financial industry PACs were particularly generous to Dodd. PACs controlled by UBS and Ernst & Young each chipped in $5,000. The Mortgage Bankers Association added $4,500. H&R Block gave $3,000. Goldman Sachs, Vanguard, Charles Schwab, and US Bank kicked in $2,000 each. And the Futures Industry Association and the Independent Community Bankers of America donated $1,000 a piece. Among Dodd's donors is a who's who of finance industry heavy-hitters. They include Leon Black ($2,400), the billionaire founder of private equity firm Apollo Management; Mark Fetting ($2,000), the chairman and CEO of asset management firm Legg Mason; Alan Leventhal ($1,500), chairman and CEO of Beacon Capital Partners; and Rodger Lawson ($2,300), the president of mutual fund giant Fidelity Investments. (Along with Lawson, at least a dozen other high-level Fidelity employees donated $1,000 or more to Dodd, and the company's PAC gave $5,000.) Also appearing on Dodd's donor list are dozens of top executives at various firms including Citigroup, Citizens Financial Group, and D.E. Shaw & Company, the New York-based hedge fund.

After his industry backers, one of Dodd's largest donor constituencies is Washington lobbyists. Ogilvy lobbyist (and onetime chief of staff to Sen. Kit Bond of Missouri) Julie Dammann, whose finance industry clients have included the private equity firm Blackstone Group, AIG, Visa, and Fannie Mae, contributed $1,000. So did lobbyists Thomas Quinn and Jeffrey Kurzweil, who are both on the payroll of Beacon Capital Partners. (In 2008, Quinn also lobbied for Bear Stearns, the National Association of Credit Unions, and State Street Corporation, among other finance sector clients.) Former Dick Gephardt aide Steve Elmendorf, whose firm has recently lobbied for Citigroup, Ernst & Young, the Managed Funds Association, and other financial clients, donated $2,400.

Dodd, who in 2007 blasted the "predatory, abusive, and irresponsible" practices of subprime lenders, also received campaign money from one of the subprime industry's chief lobbyists, Wright Andrews ($1,000). Andrews has run several cleverly named industry-backed trade groups, including the Coalition for Fair and Affordable Lending and the Responsible Mortgage Lending Coalition. Along with his wife, Lisa, once a chief in-house lobbyist for Ameriquest Mortgage, which shut down in 2007, Andrews "coordinated" the subprime industry's lobbying campaign to blunt state efforts to crack down on risky lending, according to the Wall Street Journal.

Asked about Dodd's extensive contributions from Big Finance, Bryan DeAngelis, the senator's press secretary, insisted Dodd was not in Wall Street's pocket. "Campaign contributions do not and never have influenced Senator Dodd's agenda and priorities," DeAngelis wrote in a statement to Mother Jones. "As his record reflects—from working to stop abusive credit card practices and predatory lending to opposing industry-friendly bankruptcy reform and tax breaks for companies that ship jobs overseas—Chris Dodd's priorities are not determined by the financial industry. His work is always and has always been about representing the interest of the people of Connecticut." But it's not clear that the people of Connecticut want Dodd around any longer. Big Finance execs and lobbyists, on the other hand, obviously believe it is very much in their interest to keep Dodd where he is.

Steven Rattner, the leader of the Obama administration's auto task force, was one of the executives involved with payments under scrutiny in a probe of an alleged kickback scheme at New York state's pension fund, according to a person familiar with the matter. A Securities and Exchange Commission complaint says a "senior executive" of Mr. Rattner's investment firm met in 2004 with a politically connected consultant about a finder's fee. Later, the complaint says, the firm received an investment from the state pension fund and paid $1.1 million in fees. The "senior executive," not named in the complaint, is Mr. Rattner, according to the person familiar with the matter. He is co-founder of the investment firm, Quadrangle Group, which he left to join the Treasury Department to oversee the auto task force earlier this year.

Neither Mr. Rattner nor Quadrangle has been accused of any wrongdoing. Mr. Rattner did not return calls for comment. A spokeswoman for the Treasury, which is in charge of the auto task force, said that "during the transition, Mr. Rattner made us aware of the pending investigation." In the long-running pay-to-play case, authorities allege that about 20 investment firms made payments in exchange for investments from the $122 billion New York State Common Retirement Fund. The case, being investigated by New York Attorney General Andrew Cuomo and the SEC, has led to three criminal indictments and a guilty plea. The attorney general's office and the SEC declined to comment. The next phase of the investigation is expected to focus more on the investment firms, which include Quadrangle, Carlyle Group and Odyssey Investment Partners.

The three firms say they have cooperated and are not targets of the investigation. Authorities are trying to determine whether any of the firms violated securities laws in paying fees to a placement agent for access to the state pension fund. The main legal issue for the investment firms turns on whether they knew, or should have known, that fees they paid to certain entities for access to the New York fund were legitimate or were improper kickbacks, and whether they were properly disclosed, according to people familiar with the matter. The SEC alleges in its complaint that a meeting was arranged between the senior Quadrangle executive and a brother of New York's then-deputy comptroller to discuss acquiring the DVD distribution rights to the low-budget film, "Chooch." The deputy comptroller, now under indictment, and his brothers produced the movie.

Quadrangle, through an affiliate called GT Brands, agreed to acquire the rights for $88,841, and three weeks later the deputy comptroller told the senior Quadrangle executive that Quadrangle would get a $100 million investment from the pension fund, according to the complaint. Quadrangle then paid the $1.1 million finders fees to a company affiliated with the political consultant, according to the complaint. GT Brands was a DVD publishing company that did business as GoodTimes Entertainment. One person familiar with the deal says it was a standard movie deal, where GoodTimes made an investment and the producers of the movie received payments after GoodTimes recouped its investment.

Mr. Rattner, 56 years old, is a veteran deal maker who co-founded New York-based Quadrangle in 2000 after spending years as an investment banker at Lehman Brothers, Morgan Stanley and Lazard Freres & Co., where he rose to the No. 2 spot. Earlier this year, President Barack Obama tapped him to lead a task force of two dozen people to figure out how to restructure ailing U.S. auto makers General Motors Corp. and Chrysler LLC. Placement agents play a key role in the hedge fund and private-equity fund-raising business. Typically, they serve as middlemen between investment firms and prospective clients, and get a percentage of the investments as fees.

Hank Morris, who was the top political adviser and chief fund-raiser for former New York Comptroller Alan Hevesi, was a placement agent named in the SEC complaint. The deputy comptroller, who helped produce "Chooch," was David J. Loglisci. Both men were arrested last month and charged in a 123-count state criminal indictment that included money-laundering, enterprise-corruption and bribery charges. The SEC filed civil-fraud charges against the two men. Attorneys for the two men have denied the accusations. The SEC suit charges that Mr. Loglisci told firms interested in managing New York's pension money that they should hire Mr. Morris. After the money managers agreed to pay Mr. Morris a fee, then "Loglisci approved the proposed deal with the investment management firm," the SEC alleged.

The SEC complaint says that in 2004, the senior Quadrangle executive met with Mr. Loglisci to solicit an investment for the firm. In December, "Morris met with the Quadrangle executive and solicited a finder fee arrangement between Quadrangle and Morris," the complaint alleges. Although Quadrangle had already retained a placement agent, the complaint says, "Quadrangle entered into a written agreement...to pay Searle [a placement agency affiliated with Mr. Morris] 1.1% of any amount invested by the Retirement Fund with that private equity fund."Quadrangle paid a $1.125 million fee to Searle, with Mr. Morris receiving 95% of that amount, the complaint alleges. The SEC alleges that Quadrangle wasn't the only firm to invest in "Chooch." An executive at the private-equity firm Riverstone Holdings, which paid fees to Searle through a joint venture with Carlyle, invested $100,000 in the movie, according to the SEC complaint. Riverstone has said it has cooperated with the investigation, and that neither the company nor its executives have been advised that they are targets.

Edward Liddy, the dollar-a-year chief executive leading the American International Group since its bailout last fall, still owns a significant stake in Goldman Sachs, one of the insurer’s trading partners that was made whole by the government bailout of A.I.G. Mr. Liddy earned most of his holdings in Goldman, worth more than $3 million total, as compensation for serving on the bank’s board and its audit committee until he stepped down in September to take the job at A.I.G. He moved to A.I.G. at the request of Henry M. Paulson Jr., then the Treasury secretary and also a former Goldman director.

Details about his holdings were disclosed in Goldman’s proxy statement and confirmed by an A.I.G. spokeswoman. Mr. Liddy had already owned some stock in Goldman Sachs before joining its board in 2003. He has said that he considers his work at A.I.G. to be a public service, performed on behalf of the taxpayers, who ended up with nearly 80 percent of the insurance company. His goal is to dismantle the company and sell its operating units, using the proceeds to pay back the rescue loans. On Thursday, A.I.G. said it had sold its car insurance unit, 21st Century Insurance, to Zurich Financial Services Group for $1.9 billion.

Along the way, Mr. Liddy has clearly disclosed that A.I.G. was serving as a kind of conduit, with much of the rescue money passing through and ending up in the hands of A.I.G.’s trading partners. Still, his stake could represent a potential conflict and is likely to reignite questions about Goldman’s involvement in A.I.G., and about why taxpayer money was used to shield A.I.G.’s trading partners from losses, when asset values plunged everywhere and most investors suffered greatly. Had A.I.G. simply declared bankruptcy, the financial institutions doing business with it would have ended up in court, as they did in the case of Lehman Brothers, fighting to get pennies on the dollar for their claims.

Instead, Goldman Sachs received $13 billion of the Federal Reserve’s rescue money to close out various contracts it had outstanding with A.I.G. It was one of the biggest beneficiaries of the government rescue. A spokeswoman for A.I.G., Christina Pretto, dismissed any suggestion that Mr. Liddy’s financial ties to Goldman might have shaped his actions at A.I.G. "A.I.G. is a large institution that engages in standard commercial activity with companies all over the world," Ms. Pretto said. "These activities are handled in the normal, day-to-day course of business and rarely, if ever, rise to the level of the C.E.O."

She said in particular that Mr. Liddy was not involved in the discussions of how to close out the contracts of A.I.G.’s counterparties in derivatives and other forms of trading. "Discussions regarding these matters were handled exclusively by the Federal Reserve Bank of New York," Ms. Pretto said. According to Goldman’s proxy, Mr. Liddy holds 18,244 units of restricted stock, which would be worth about $2.2 million if they were sold at today’s market price. The rest of his holdings are in common stock. Restricted stock cannot be sold without incurring significant tax penalties, but the proxy said that Mr. Liddy’s restricted units would be converted to common shares on May 9.

Officials of the Federal Reserve, which initiated the bailout of A.I.G. last September, have said they were not happy about having to pour public resources into private sector companies, but felt that they had to do so to avoid a devastating chain of losses at financial institutions all over the world. A.I.G. has operations in more than 100 countries. Before it nearly collapsed, officials had already been calling for a new international regulatory framework, to contain this systemic risk, but so far no specific proposals have been introduced.

Maryland Congressman Elijah Cummings (D-Md.), a senior member of the House Committee on Oversight and Government Reform, has come out swinging today in response to Tim Carney's Washington Examiner story that broke the news that AIG CEO Edward Liddy owns $3 million of stock in Goldman Sachs. Here's his full statement.

"I am extremely concerned by recent media reports that AIG CEO Edward Liddy owns more than $3 million of stock in Goldman Sachs, which topped the list of companies that received billions of dollars in counterparty payments from AIG. Regardless of whether or not Mr. Liddy is acting in the best interest of AIG or of his stock in Goldman, even the appearance of conflict of interest is a reason for alarm. "One of the most important components in restoring our nation’s economy is confidence. Taxpayers must have confidence in how their money is being spent, and investors must have confidence in the markets. Because AIG has received more federal aid than any other company, it is critical that the company’s operations and chief officers have the confidence of the Congress and the American people.

"The actions of CEO Edward Liddy have consistently eroded the confidence of myself and many of my constituents in his ability to lead AIG. Mr. Liddy has often pointed to his dollar-a-year salary as evidence of his pure intentions, but his neglect to mention the bonus he is eligible to receive next year, combined with the $3.2 million he owns in Goldman stock, cause his argument to lose credibility. "For months, I have been calling on Mr. Liddy to resign from his position at the helm of AIG, and in light of the new information about his stock holdings at Goldman, I renew that call today. It is critical that we have full transparency and accountability from all parties who owe a fiduciary duty to the American taxpayers."

AIG made the first big dent Thursday in its mountain of IOUs to taxpayers. The New York-based insurer agreed to sell its U.S. car insurance business to a unit of Zurich Financial Services for $2 billion in cash, notes and debt assumption. The sale, which is subject to regulatory approval, is expected to close later this year, an AIG spokesman said. The sale of 21st Century Insurance to Farmers Group comes just a month after AIG -- which has received federal assistance exceeding $182 billion since its derivatives-fueled implosion last fall -- had the terms of its federal lifeline restructured for the third time.

The company is trying to sell assets to raise cash to whittle down its gigantic obligations to the Treasury and the Federal Reserve Bank of New York. But progress has been slow. Financing for would-be buyers has been hard to come by, and Congress has been extremely critical of the ever-rising price tag of AIG's bailout. "We are very pleased to reach agreement on a $2 billion transaction, especially in this market environment," said CEO Edward Liddy. "In addition, we are moving forward with discussions for several other transactions, and we continue to evaluate how best to assure the continued strength and success of all of AIG's businesses." Liddy was installed last September after the government took a 79% stake in AIG in exchange for what started out as an $85 billion emergency loan. In return, AIG pledged to sell assets to raise cash that would be used to repay taxpayers.

Since then, with the financial markets remaining deeply stressed, AIG's need for cash has grown. As a result, the task of breaking up the company, which looked difficult when Liddy started in September, now appears to verge on the impossible. In October, the company got a $37 billion loan from the New York Fed to help unwind its securities lending business, which like certain other parts of AIG got entangled in ill-advised investments in subprime mortgage-backed securities. That agreement boosted the company's debt to taxpayers to $122 billion. A month later, the government restructured the terms of the deal, converting part of the Fed loans into a $40 billion Treasury equity investment and reducing the interest rate on the remaining debt.

The government also set up two programs aimed at extricating AIG from the most toxic part of its derivatives business. Those efforts brought the tab to $152 billion. And in March, another restructuring gave the government stakes in two foreign life insurance companies and a share of cash flows from some domestic insurers. In exchange, the Treasury created a $30 billion credit line for AIG, which as yet is undrawn. While the government has been busy writing checks to the company, the deals AIG has done so far have generally have been small. The 21st Century sale will bring AIG $1.5 billion in cash -- more than what the company had received in publicly disclosed divestitures up until now.

Also Thursday, AIG sold its private bank unit to Aabar Investments of Abu Dhabi for $308 million in cash and loan assumption. Earlier this month, the company sold its Thai banking operations in exchange for $45 million in cash and debt repayment of $495 million; dealt its Canadian life insurance operations to Bank of Montreal for $263 million; and dispatched its Hartford Steam Boiler industrial insurer to Munich Re for $739 million, plus $76 million of debt assumption. All told, the deals announced Thursday bring the cash AIG has raised during April to $2.8 billion.

General Motors Corp. is planning to make a formal offer to all bondholders by April 27 to exchange their $27.5 billion in claims for equity, according to a person with knowledge of the discussions. GM, facing a June 1 deadline for a U.S.-backed bankruptcy, was told this week by President Barack Obama’s auto task force to try to restructure its debt out of court, said people familiar with the matter, who asked not to be identified because the talks are private. The Detroit-based automaker is planning to announce the offer within 11 days, because the U.S. Securities and Exchange Commission requires that investors have a month to decide whether to participate, according to one of the people. Bondholders also may be offered accrued interest in cash, though the terms of the exchange are preliminary, the person said.

"Our bet would be the bondholders would probably go into court because they’ll be able to get more concessions," said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan. "You’re going to get equity anyways. You might as well hold out until you can get more concessions" from management and the unions. The Obama administration said last month that GM’s plan to return to profit wasn’t aggressive enough and ordered new Chief Executive Officer Fritz Henderson to cut its debt by more than initially demanded. GM will be forced to go into a government- supported bankruptcy without deeper cost cuts from its creditors by June 1, it, the administration said.

GM is trying to prove it’s viable, a U.S. requirement to keep $13.4 billion in federal loans. The original loan terms called for GM to slash two-thirds of its bonds through a debt- for-equity exchange. GM also needs the United Auto Workers to agree to cut a cash contribution to a union retiree health-care fund from $20.4 billion to less than $10.2 billion. The UAW retiree health-care fund will probably get preferential treatment over other unsecured claims in GM’s restructuring because GM needs a cooperative union to build its vehicles once it reorganizes, according to people familiar with the plans.

GM has thousands of bondholders ranging from institutional investors including insurers and pension funds to individual retirees. A 10-member ad hoc committee of bondholders, whose members include San Mateo, California-based Franklin Resources Inc. and Fidelity Investments of Boston, has rejected two plans they’ve been shown since December. "A successful bond exchange is an essential element of our restructuring efforts, and we are working aggressively to launch the exchange," Renee Rashid-Merem, a GM spokeswoman, said. "However we won’t speculate on timing or terms of the transaction." Before CEO Rick Wagoner was removed last month, bondholders were balking at a proposal from GM that called for them to swap more than three-quarters of their stake for equity, according to a person familiar with the talks.

That offer would have given bondholders 90 percent of the equity in the reorganized automaker and a combination of cash and new unsecured notes, the person said at the time. The U.S. government is also considering swapping some of the $13.4 billion it loaned GM for an equity stake in a stripped-down version of the carmaker, people familiar with the matter said. A government stake would mean a smaller share of the new company for bondholders. GM’s $3 billion of 8.375 percent bonds due in 2033 rose about 0.7 cent to 9.25 cents on the dollar at 3:45 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 89 percent.

GM also may drop its Pontiac and GMC brands as it seeks deeper cuts, people familiar with those discussions said. The largest U.S. automaker had originally planned to sell or close its Saab, Saturn and Hummer brands. Chrysler LLC, facing an April 30 deadline to restructure and form an alliance with Fiat SpA, has been negotiating with its secured lenders and the United Auto Workers union. The Auburn Hills, Michigan-based automaker borrowed $4 billion from the U.S. Obama said Chrysler, the third-largest U.S. automaker, could borrow as much as $6 billion more to restructure if it teams up with Fiat.

Any hope of a high-speed bankruptcy by General Motors faces a serious obstacle: a judge — not the Obama administration, not G.M. management and not the company’s creditors — would reign in court. A bankruptcy judge would be required by law to listen to unions, whose members fear for their jobs, benefits and pensions. And the judge would have to pay attention to creditors, including bondholders frustrated by how much they stand to lose if G.M. is broken up into "good" and "bad" companies as the administration is planning. Even a judge sympathetic to the administration — and the administration would look for a sympathetic court — might be reluctant to rubber-stamp that plan. "Once you’re in, nobody knows where it’s going because anyone can come into court and say no, no, no," said Sandra E. Mayerson, head of the insolvency practice in the New York law office of Squire, Sanders & Dempsey. "I’ve had preplanned bankruptcies that we thought would be out in 90 days but we were in for a year."

While a bankruptcy judge agreed to a lightning-quick sale of Lehman Brothers assets last fall, he did so only after a parade of government regulators insisted that a failure to sell could undermine the world financial system. That claim would be a stretch for G.M., whose assets are factories, cars and other tangible goods that, unlike Lehman’s financial contracts, have value that is unlikely to evaporate quickly. "It’s a very different kind of business than Lehman," said Howard Seife, head of the bankruptcy and financial restructuring practice at Chadbourne & Parke in New York. Casting aside the deliberative processes of bankruptcy would undoubtedly lead other companies to argue for the same treatment in the future. The judge would want to weigh carefully the stakes, given G.M.’s size and its close ties to companies around the world.

Unionized employees and retirees would ask that their contracts be protected, and the Bankruptcy Code has provisions specifically requiring good-faith negotiations before labor agreements can be modified. Such talks could easily take many months. Bankruptcy cases often drag on far longer than anticipated, slowed by unexpected obstacles to reorganization. The auto parts company Delphi, once a unit of G.M. and now a supplier, has languished in bankruptcy proceedings for four years, twice as long as originally planned, for example. Separating and selling off G.M.’s more valuable assets, a strategy pursued at troubled banks (usually outside of bankruptcy, it should be noted), would most likely pit the company’s financial advisers against those working for creditors.

"Creditors may think Buick is their premier line, management may think Pontiac is their premier line," Ms. Mayerson observed. That argument will delay important decisions about the company’s future, she added. "It really isn’t an asset problem at G.M. so much as a management problem." Even if a judge went along with the government’s plan to split the company, that judge would want plenty of legal cover. Gathering and presenting evidence that the split-up is the best option would take time. Typically, companies sell off assets to third parties as part of a reorganization in Chapter 11. Plans for G.M. would go further, selling virtually all the viable parts of the company very quickly to a new one created solely to buy it. "What’s driving this is the concern that the customer is not going to stand for a three-year bankruptcy," said a person briefed on the government’s plan who insisted on anonymity because discussions are continuing. "The revenues will just stall out."

Allowing the automaker to sell off the good assets would essentially sidestep the rest of the bankruptcy process, lawyers said, especially the nettlesome requirement that creditors approve a plan of reorganization. Once blessed, that tactic would be alluring to other troubled companies. "If you could do this, it’s too cheap a trick — everyone would do it," said Lynn M. LoPucki, a law professor at the University of California, Los Angeles. "There would be no other kind of bankruptcy remaining." Lehman Brothers conducted a sale within days of its bankruptcy filing, holding an auction under Section 363 of the Bankruptcy Code, which the administration’s plan could also use. But in Lehman’s case, an outside buyer, Barclays, bid on the assets, Professor LoPucki said. "Here, there is no buyer," he said. "G.M. is selling itself to itself. That transaction has no economic reality."

The transaction could have very real implications, though, for creditors and unionized workers. If union contracts on pensions, employment and benefits remain tied to the old G.M., employees and retirees could be devastated financially. If the contracts move to the new, good company, the surviving business would look considerably weaker. That creates a political problem that would make a rapid, clean bankruptcy unlikely. "It’s going to be about the union and the pensions," said Ms. Mayerson, the bankruptcy lawyer. "And I don’t see any way that this is a quickie bankruptcy. After all, it took them 30 years to get into this mess."

General Motors Corp., operating with $13.4 billion in U.S. loans, will probably still need $4.6 billion in additional aid this quarter, Chief Executive Officer Fritz Henderson said. Henderson didn’t specify timing for when funding would be needed. GM had initially asked for as much as $16.6 billion in additional loans. GM is still working with U.S. Treasury officials about its restructuring plan and trying to avoid bankruptcy, "much like a private-equity due-diligence process," Henderson said on a conference call. GM is considering the financial implications of all of its operations after the Obama administration said last month that GM’s initial plan to cut costs and keep a government loan aren’t sufficient. Henderson says talks continue with debt holders and unions to get deeper cuts as the automaker plans for both in and out-of-court restructuring.

The Detroit automaker has decided to keep its AC Delco parts unit and has about three bidders for its Hummer brand, Henderson said. GM also said it has several parties interested in buying its Saturn and Saab brands and investing in its German Opel unit. To stay out of court protection, Henderson needs agreements from unions and debt holders for savings beyond GM’s Feb. 17 proposal for slashing $47 billion in unsecured claims by 59 percent. GM plans to make a formal offer to bondholders by April 27 to exchange their $27.5 billion in claims for equity, according to a person with knowledge of the discussions. President Barack Obama’s automotive task force told GM to try to restructure its debt out of court, people familiar with the matter said.

The International Monetary Fund has warned of "worrisome parallels" between the current global crisis and the Great Depression, despite the unprecedented steps already taken by central banks and governments worldwide. This recession is likely to be "unusually long and severe, and the recovery sluggish," said the Fund, releasing two advance chapters from its World Economic Outlook. However, it warned there is a risk that it could spiral down into a full-blown slump unless further action is taken to stop "feedback effects" gathering force.

Dominique Strauss-Kahn, head of the IMF, said millions of people risk being pushed back into poverty as the economic storm ravages the most vulnerable countries. "The human consequences could be absolutely devastating. This is a truly global crisis, and nobody is escaping," he said. "The free-fall in the global economy may be starting to abate, with a recovery emerging in 2010, but this depends crucially on the right policies being adopted today." Mr Strauss-Kahn called for a urgent action to "cleanse banks" of toxic assets and for further fiscal stimulus beyond the 2pc of global GDP already agreed. The snag is that high-debt countries may have hit the limits already.

"The impact becomes negative for debt levels that exceed 60pc of GDP," said the Fund. While no countries were named, this would raise questions about Japan, Germany, France, Italy and ultimately Britain and the US after their bank rescues. The IMF said the US is at the epicentre of this crisis just as it was in the Depression, setting the two episodes apart from normal downturns. However, the risks are greater this time. "While the credit boom in the 1920s was largely spec?ific to the US, the boom during 2004-2007 was global, with increased leverage and risk-taking in advanced economies and many emerging economies. Levels of integration are now much higher than during the inter-war period, so US financial shocks have a larger impact," it said.

The IMF said the global financial system is still under acute stress, with output tumbling and inflation falling towards zero in key nations. "The risks of debt deflation have increased," it said. Abrupt halts in capital flows can have "dire consequences" for emerging economies, it said. Eastern Europe has already suffered the effects, with a 17.6pc fall in industrial production in February. The region is highly vulnerable to the credit crunch since it owes more than 50pc of its GDP to Western banks. Synchronised world recessions striking all major regions are "historically rare" events, the Fund said. They last one and a half times as long typical downturns, and are followed by painfully slow recoveries.

House Speaker Nancy Pelosi is calling for a congressional commission to investigate the causes of the U.S. financial crisis, a spokesman for the California Democrat said. Speaking to the Commonwealth Club of California, Ms. Pelosi said Wednesday she had spoken to Treasury Secretary Timothy Geithner about creating a panel modeled after the Pecora Commission, which studied the 1929 stock market crash. The Pecora Commission eventually helped pave the way for Securities Act of 1933 and the Securities Exchange Act of 1934 and the creation of the Securities and Exchange Commission in 1935. Ms. Pelosi's comments were reported Thursday in the San Francisco Chronicle.

Details have yet to be sorted out. Pelosi spokesman Brendan Daly said the speaker plans to talk to fellow lawmakers next week about the proposal, when Congress reconvenes after a two-week recess. Mr. Daly said the commission "would be a congressional panel," rather than an outside commission. Several committees have already held hearings and are conducting inquiries into financial meltdown. But Ms. Pelosi stressed a special panel is a priority, and said she would push for the creation of the commission "even if it is only in the House of Representatives." She said Americans needed "to have a clearer understanding of how we got here."

Car sales in Europe fell by 17.2% in the first quarter of this year, underlining the damage to consumer confidence inflicted by the recession and credit crunch. Figures from ACEA, the pan-European auto industry body, showed today that sales fell 9% last month, with sales in eastern Europe down 25% and in the west by 8%. The slump in new car sales would have been even more dramatic without the scrappage incentives on offer in about a dozen EU countries to persuade consumers to trade in their old models for fuel-efficient vehicles. In Germany, where the government has just agreed to extend a scheme offering €2,500 (£2,200) per consumer in the face of a headlong rush to showrooms, the market has grown this year – it is up 18% and is the only one in western Europe to experience growth. In March, sales were 35% higher than a year ago.

Spain, which has a more modest version of the scheme, saw a decline of 43.1% and Britain, which has yet to adopt a scrappage scheme despite months of industry pressure, one of almost 30%. Italy and France, which both have such schemes, saw falls of 19% and 4% respectively. In Ireland, the worst hit of the 16 eurozone economies, sales fell 65% and Iceland faced a 91.3% drop. The overall European market in the first three months of 2009 saw sales fall from 4.15m vehicles a year earlier to 3.43m – a less severe decline than in the US, where the Big Three firms are fighting for survival. In eastern Europe, both Poland and the Czech Republic, which are weathering the recessionary storm relatively well, saw a growth in sales of 2.5% and 0.9% last month, with Slovakia, protected within the eurozone, showing a jump of 18.2% after introducing a scrappage scheme.

Wholesale prices in Germany dropped 8.0 percent in March compared with the same month last year, the biggest year-on-year decline since January 1987, the German Federal Statistical Office said Wednesday. Compared to February, however, wholesale prices declined 0.9 percent, said the Wiesbaden-based statistics office. Crude oil prices have retreated 66 percent from a record 147 U.S. dollars per barrel in July 2008. As a result, solid fuels and petroleum products were 21.4 percent cheaper in March than a year earlier, the statistical office said. Prices of grain, seeds and feed declined 42.6 percent in the past 12 months.

Statistics show that Germany's inflation has fallen to its lowest level in almost 10 years, as the global financial crisis has dragged the European Union's biggest economy into its worst recession since World War II. European Central Bank (ECB) council member Athanasios Orphanides told local media a day earlier that the risk of deflation may push further monetary easing. The ECB has lowered its benchmark interest rate by 3 percentage points since early October to 1.25 percent. The German government has announced plans to spend about 80 billion euros (106 billion U.S. dollars) over two years to support the economy and boost consumers' spending power. The measures include investment in schools and roads, lower health-insurance payments, tax breaks and incentives to buy new cars.

India and China may press for the sale of the entire gold reserves of the International Monetary Fund (IMF) to raise money for the least developed countries. The IMF holds 103.4 million ounces (3,217 tonnes) of gold that, if sold, can fetch about $100 billion. A draft paper exchanged between New Delhi and Beijing proposes that the gold be sold in bullion markets over a period of two to three years. The money thus raised must be used in tackling poverty in the poorest nations. "We have been discussing with China a common position on the subject," a senior finance ministry official told Financial Chronicle. Both prime minister Manmohan Singh and Chinese president Hu Jintao will have to clear the proposal before the representatives of the two countries can take it up at the IMF spring meeting in June in Washington.

The G20 heads of state meeting in London earlier this month agreed to sell a part of the IMF gold to raise $6 billion for poor countries during 2009-11. This was a component of a $1.1 trillion package worked out by G20. The World Bank has estimated that over 90 million people may be pushed into poverty in the global economic turmoil. "We are working on a more ambitious proposal of selling the entire gold as it is an idle asset with the IMF," said the official. India and China are looking at three ways of using the money so raised. 1) The $100 billion be invested to improve IMF’s liquidity. 2) The money be committed to improving incomes of the poorest countries. 3) A mix of the first two options be considered.

How the sale will affect the bullion market, with attendant problems for currencies, has not been assessed. A large part of the gold may find its way into central banks and private players. Since most of its will be out of reach for retail markets, gold prices may not get hammered. Globally gold prices now are in the $870 - $950 per ounce range. India and Turkey, traditionally big buyers of gold, have not bought much lately because of low domestic demand. During January to March, India bought a paltry 1.2 tonnes. (Normally, India imports about 700 tonnes a year.) Turkey bought just 40 kg last month.

K Shivram, vice- president of the World Gold Council, said, "Whether the gold will be sold or not is an open question." If the sale did take place it would be staggered, he said. There could be a temporary correction in gold prices but the market would bounce back. He added that when G20 announced the limited sale of gold, the prices that had been ruling around $950, dropped to $875. "But they are again moving up." In India, gold now quotes at Rs 14,500 to 15,000 per 10 gm. Karvy Comtrade, a commodity brokerage, expected the price to drift to Rs 13,000 by the end of June. He did see an impact of IMF gold sales in the short- to- medium term. Vibhu Ratandhara, assistant vice- president of Bonanza Commodity, said much depended on the US, which had 17 per cent equity in gold at the IMF.

The gold, if cold, would go mostly to central banks. He said there could be some impact on retail prices which might drop by Rs 400 per 10 gm. The IMF has built its gold reserves over 40 years. The historical value of the gold, as declared in its balance sheet, is $9.3 billion. Four major sources helped build the reserves. One, member- countries paid in gold their 25 per cent initial quota subscriptions. Two, interest charges on credit given by it were collected in gold from many countries. Three, member-countries can sell gold to it to fight a temporary liquidity crisis. And four, they can make loan repayments in gold.

IMF Managing Director Dominique Strauss-Kahn said on Thursday that China's currency remained significantly undervalued, although the country's efforts to spur domestic growth would help with adjustment. "The renminbi is still significantly undervalued, there is a long way to go, but correct policies are in place," Strauss-Kahn told reporters at the National Press Club in Washington.

He was responding to a question about whether the Fund agreed with the United States' stance on China. On Wednesday, the U.S. Treasury said it did not think China was keeping its currency artificially low to give it an unfair trade advantage, although it did say the yuan was undervalued. Strauss-Kahn said China's heavy stimulus spending would help its economy shift toward domestic consumption and away from exports, something that should help pare China's huge reserves and rebalance the global economy.

(1) The autodafé of the unsecured creditors is coming to a US bank near youA binding budget constraint sure concentrates the mind, even for the US Treasury. There is just one way to make the US government’s policy towards the banks work. That is for the Congress to vote another $1.5 trillion worth of additional TARP money for the banks - $1 trillion to buy the remaining toxic assets off their balance sheets, and $0.5 trillion worth of additional capital. The likelihood of the US Congress voting even a nickel in additional financial support for the banks is zero. There is no real money left in the original $700 bn TARP facility - somewhere between $ 100 bn and 150 bn - to do more than stabilise a couple of pawn shops. The Treasury has been playing for time by raiding the resources of the FDIC (which, apart from the meagre insurance premiums it collects, has no resources other than what the Treasury grants it) and of the Fed.

The Fed has taken an open position in private credit risk to the tune of many hundreds of billions of dollars. Before this crisis is over, its exposure to private sector default risk could be counted in trillions of dollars. In addition to looking for money in off-budget and off-balance sheet places (and out of sight of Congress), the US Treasury has also tried to hide true extent of the problems of the US banks. In addition to supporting the FASB’s recent proposals for increasing managerial discretion as to the way illiquid assets are accounted for (that is, condoning the issuance of another license to lie), the Treasury appears to be using the ‘Stress Tests’ announced as part of the Financial Stability Plan, as a mechanism to play for time and gamble for resurrection.[1] I base this on what I have been picking up about the reality of these Stress Tests.

1. The actual decline of the real economy thus far is already steeper and deeper than assumed in the Stress Tests.2. The Stress Tests focus on the 40% of the banks’ balance sheets consisting of securities, rather than on the 60% consisting of conventional loans. The securities (including the toxic waste) is where most of the old problems of the banking sector are concentrated, that is the problems incurred as a result of the pre-August 2007 speculative frenzy. The loan book contains the stuff that will go bad as a result of the steep and deep contraction in real economic activity the US has been in since Q4, but that will not show up in the banks’ reports until this summer at the earliest.3. The bulk of the information provided to the authorities by the banks is private information to the banks that is virtually impossible to verify independently. Too many banks have lied about their exposure too many times for me to feel confident about the quality of the information the banks have been providing as part of these Stress Tests.

As a result I now expect a clean bill of health for the banks from the Stress Tests. For most banks this will turn out to be incorrect before the end of the year. At that point, the de facto insolvency of much of the US border-crossing banking system will become so self-evident, that even the joint and several obfuscation of banks and Treasury will be unable to deny the obvious. There still will be no fiscal resources available to sanitise the banks’ balance sheets by purchasing or guaranteeing the old toxic assets and new bad assets. At that point, only the ‘good bank solution’, which requires either a serious hair cut for unsecured creditors or a mandatory conversion of debt into equity will be viable, simply because the bad bank solution requires additional public money which isn’t there. (You create a new good bank out of the assets of the old bank and the insured deposits and counterparty claims on the old bank, leaving the unsecured creditors of the old bank with a claim on the equity in the new good bank; a bad bank requires funds to buy the toxic and bad assets from the old bank and addition resources to capitalise the bad bank).

We will have wasted a lot of time - the good bank solution and the slaughter of the unsecured creditors should have been pursued actively as soon as it became clear that most of the US border-crossing banking system was insolvent, but for past, present and anticipated future tax payer support. If the Treasury can be pushed into a pro-active policy by declaring, just before the beginning of the weekend, that most of the banks undergoing the Stress Test have failed them and moving these wonky institutions straight into the FDIC’s special resolution regime where they can be restructured according to the good bank model, we could have well-capitalised banks capable of new lending and borrowing by the beginning of next week. The same policy should be pursued wherever banks have failed: it never makes sense to put the interests of the unsecured creditors before those of the tax payers. It is bad economics in the short run and in the long run. And it is political poison. I fear, however, that only in those countries where there is no fiscal spare capacity (as in the US, for political reasons or in Iceland, for economic reasons), the right solution to bank restructuring will be adopted. Elsewhere the unsecured creditors will continue to feed off the carcases of the tax payers and the beneficiaries of public spending programs that will have to be sacrificed to foot the bill.

(2) Too big to fail means too bigNo country should ever find itself in position of Iceland, with systemically important banks or other financial institutions that are too large to save. The fiscal spare capacity of the government (its ability to raise future primary (non-interest) surpluses has to be sufficient to take care of any possible solvency gap in the systemically important part of their financial institutions. If the too big to save problem can be resolved rather easily, the too big to fail issue has been with us for so long that one assumes there must be powerful forces sustaining large and complex financial institutions. The assumption is correct, but these forces are political, not economic or efficiency-related. Economies of scale for banks are exhausted well before a balance sheet size of $100 bn is achieved. Synergies between commercial banking and investment banking activities are essentially non-existent. The multiplication of products and services offered and of roles played by a financial institution can be privately profitable, because it allows the exploitation of the gains from conflicts of interest. Chinese walls, the industry’s answer to potential conflicts of interests, are aptly named. The Great Wall of China never kept the barbarians out or the Chinese in. Chinese Walls in banks, auditing companies, rating agencies and other financial enterprises don’t stop any information that is commercially profitable from getting across the boundaries. Financial supermarkets lose focus and ultimately become Citigroup - a conglomeration of worst-practice from across the financial spectrum.

There is no ‘too interconnected-to-fail’ problem separate from the ‘too-big-to-fail’ problem. I can be infinitely interconnected. If I operate on a small scale, I and my interconnections are immaterial from a systemic stability perspective. Banks and other financial supermarkets want to be large for two reasons. The first is monopoly power. This causes banks to want to be large in any specific activity. It’s common to every industry and to all human activity. That’s what we ought to have anti-trust or pro-competition policies for. The second reason is that financial supermarkets can shelter non-systemically important profitable operations under the heavily subsidised public umbrella provided by the state to a few systemically important operations (deposit taking, payment, clearing and settlement systems, counterparty and custodial services) though lender-of-last-resort support (provided by the central bank) and through recapitaliser-of-last-resort support (provided by the Treasury). There is no economic reason for large banks. Therefore banks should be kept small. An obvious mechanism (apart from aggressive anti-trust policy) is to tax bank size. One way to do this is through making regulatory capital requirements increasing in the size of the bank’s activities. For instance, tier one capital as a share of (unweighted) assets could be made an increasing function of the value of the assets. Gary Becker has made a similar proposal. Governments everywhere should be focusing on breaking up banks and keeping them small. If some banking activity (or indeed any other economic activity) is deemed to have a minimum optimum scale that is makes it too large to fail, it should be publicly owned. Small is beautiful for banks.

(3) The repatriation of cross-border bankingEven if we agree that a particular bank or other financial institution is too large to fail, as soon as there are multiple fiscal authorities and border-crossing banks, there remains the unanswered question as to who should bail it out. The host country fiscal authority? The home country fiscal authority? Both together through some ex-ante or ex-post negotiated sharing rule? A dedicated supranational fiscal authority? Recent events have made it clear that, as my colleague Charles Goodhart puts it, international financial institutions are international in life, but national in death. Any systemically important financial institution has to be backed by a central bank (for short-term liquidity support) and by a Treasury or ministry of finance (for recapitalisation and other long-term financial support when insolvency is the issue). If both your liquidity and your solvency are publicly insured or guaranteed (at highly subsidised rates), you need to be regulated and supervised, lest you be tempted to take insane risks. This means that conventional border-crossing banks and other systemically important financial institutions will become a thing of the past. We will not see the kind of cross-border branch banks that we have seen during the past decades for very much longer. These foreign branches are not independently capitalised, have no independent, ring-fenced sources of liquidity, are often effectively managed from the home country (the country of the parent bank), are regulated and supervised by the home country regulator and supervisor, with lender-of-last-resort support (if any) from the home country central bank and fiscal support (if any) from the home country Treasury.

In the European Union, the relevant sections of the financial services action plan are now dead and need to be replaced unless we (a) get a single European supervisor and regulator for border-crossing banks and other systemically important financial institutions and (5) create a supranational fiscal Europe capable of dealing with insolvency threats to border-crossing systemically important financial institutions. Without a single regulator-supervisor and a sufficiently developed ‘fiscal Europe’, the principles of mutual recognition and the "single passport", a system which allows financial services operators legally established in one Member State to establish/provide their services in the other Member States without further authorisation requirements, will not be permitted to operate in the field of banking and other systemically important border-crossing financial institutions and products. Need I say Icesave? (for a further discussion of the issues involved see the paper by Charles Goodhart and Dirk Schoenmaker (2009), "Fiscal Burden Sharing in Cross-Border Banking Crises" International Journal of Central Banking, Vol. 5, No. 1, 141-165,. There will no doubt continue to be cross-border banking subsidiaries. These will, however, be independently capitalised. Their liquidity will not be pooled between parent and subsidiaries, but will have to be ring-fenced for each subsidiary. They will be regulated and supervised by the host country (as they often are today). Lender-of-last-resort support, if any, will be provided by the host country central bank (as it often is today) and fiscal support when insolvency threatens will be provided by the host country fiscal authority.

The reason for host country supervision and regulation is simple: the pain is local, so the control will have to be local. The reason for host-country bail-outs is even simpler: tax payers are national. They will not accept the use of their taxes in bail-outs of foreign shareholders, unsecured creditors and counterparties. The US authorities have been able to channel somewhere between $40 bn and $50 bn of US tax payers’ money to foreign counterparties of AIG, but that is unlikely to be the new status quo. They got away with it, thus far, because the foreign bail-outs by the US tax payer was hidden in obscure, indeed barely comprehensible financial transactions. But we should not expect the US taxpayer to stand behind foreign subsidiaries of US banks and other systemically important US financial institutions, unless a convincing case can be made that there is a material direct US financial exposure. If all the parent has at stake in its foreign subsidiary is its equity in the subsidiary, the US tax payer will not bail out the foreign subsidiary.

If the parent has further exposure, through parent-to-daughter loans, through the parent having invested in securities issued by the subsidiary or as a counterparty, there may come a point at which the financial exposure of the parent becomes sufficiently large to induce a response by the US tax payer. But given the current mood of the tax payer, I don’t expect to see rescues of foreign subsidiaries anytime soon. The same applies to the UK and to other European countries with banks that have large foreign subsidiaries. I don’t expect the British government to bail out the foreign subsidiaries of RBS, Lloyd’s Group, Barclays or HSBC. I would expect the British government to look seriously at bailing out UK subsidiaries of foreign banks, should these be threatened with insolvency, especially if most of the substantive economic activity of these banks is in the UK. For instance (what follows is a pure hypothetical - I know of nothing that would lead me to question the financial soundness of Abbey), I would not expect the Spanish government ever to bail out Abbey (owned by the Spanish bank Santander), but I would expect the UK Treasury to show an active interest.

Individual parent banks may decide to try to rescue their foreign subsidiaries, even when the subsidiaries in question appear to have gone belly-up by normal commercial standards. An extreme example of this is HSBC - reported to have incurred losses estimated to be somewhere between $30 bn and $62 bn (accounting does not appear to be an exact science) on its US credit card issuer and subprime lender, Household Finance Corporation (HFC), now renamed HSBC Finance, which it acquired at the end of 2002. Even though HSBC announced, in March 2009, that it would shut down the branch network of its HSBC Finance subsidiary in the U.S, it is continuing to operate the HSBC Finance credit card arm. HSBC could, in the opinion of many observers, have saved itself a bundle by cutting its losses and walking away from HFC when the scale of the subprime debacle became apparent late in 2007. There is a clear clash here between reputation and goodwill considerations on the one hand and throwing good money after bad on the other. This, however, is a matter for the shareholders and other stakeholders of HSBC and its management. It is a corporate governance problem. It is not a matter for the UK tax payers, unless HSBC’s HFC-related losses come to haunt it in the future and drive the parent into the arms of the UK tax payer after all. Should that happen, I hope the British authorities will take to heart all three of these ruminations.

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[1] From the Treasury’s web site:Forward Looking Assessment - Stress Test: A key component of the Capital Assistance Program is a forward looking comprehensive "stress test" that requires an assessment of whether major financial institutions have the capital necessary to continue lending and to absorb the potential losses that could result from a more severe decline in the economy than projected. Requirement for $100 Billion-Plus Banks: All banking institutions with assets in excess of $100 billion will be required to participate in the coordinated supervisory review process and comprehensive stress test."

All is not well in Obamafanland. It's not clear exactly what accounts for the change of mood. Maybe it was the rancid smell emanating from Treasury's latest bank bailout. Or the news that the president's chief economic adviser, Larry Summers, earned millions from the very Wall Street banks and hedge funds he is protecting from reregulation now. Or perhaps it began earlier, with Obama's silence during Israel's Gaza attack. Whatever the last straw, a growing number of Obama enthusiasts are starting to entertain the possibility that their man is not, in fact, going to save the world if we all just hope really hard.

This is a good thing. If the superfan culture that brought Obama to power is going to transform itself into an independent political movement, one fierce enough to produce programs capable of meeting the current crises, we are all going to have to stop hoping and start demanding. The first stage, however, is to understand fully the awkward in-between space in which many US progressive movements find themselves. To do that, we need a new language, one specific to the Obama moment. Here is a start.

Hopeover. Like a hangover, a hopeover comes from having overindulged in something that felt good at the time but wasn't really all that healthy, leading to feelings of remorse, even shame. It's the political equivalent of the crash after a sugar high. Sample sentence: "When I listened to Obama's economic speech my heart soared. But then, when I tried to tell a friend about his plans for the millions of layoffs and foreclosures, I found myself saying nothing at all. I've got a serious hopeover."

Hoper coaster. Like a roller coaster, the hoper coaster describes the intense emotional peaks and valleys of the Obama era, the veering between joy at having a president who supports safe-sex education and despondency that single-payer healthcare is off the table at the very moment when it could actually become a reality. Sample sentence: "I was so psyched when Obama said he is closing Guantánamo. But now they are fighting like mad to make sure the prisoners in Bagram have no legal rights at all. Stop this hoper coaster-I want to get off!"

Hopesick. Like the homesick, hopesick individuals are intensely nostalgic. They miss the rush of optimism from the campaign trail and are forever trying to recapture that warm, hopey feeling-usually by exaggerating the significance of relatively minor acts of Obama decency. Sample sentences: "I was feeling really hopesick about the escalation in Afghanistan, but then I watched a YouTube video of Michelle in her organic garden and it felt like inauguration day all over again. A few hours later, when I heard that the Obama administration was boycotting a major UN racism conference, the hopesickness came back hard. So I watched slideshows of Michelle wearing clothes made by ethnically diverse independent fashion designers, and that sort of helped."

Hope fiend. With hope receding, the hope fiend, like the dope fiend, goes into serious withdrawal, willing to do anything to chase the buzz. (Closely related to hopesickness but more severe, usually affecting middle-aged males.) Sample sentence: "Joe told me he actually believes Obama deliberately brought in Summers so that he would blow the bailout, and then Obama would have the excuse he needs to do what he really wants: nationalize the banks and turn them into credit unions. What a hope fiend!"

Hopebreak. Like the heartbroken lover, the hopebroken Obama-ite is not mad but terribly sad. She projected messianic powers on to Obama and is now inconsolable in her disappointment. Sample sentence: "I really believed Obama would finally force us to confront the legacy of slavery in this country and start a serious national conversation about race. But now whenever he seems to mention race, he's using twisted legal arguments to keep us from even confronting the crimes of the Bush years. Every time I hear him say ‘move forward,' I'm hopebroken all over again."

Hopelash. Like a backlash, hopelash is a 180-degree reversal of everything Obama-related. Sufferers were once Obama's most passionate evangelists. Now they are his angriest critics. Sample sentence: "At least with Bush everyone knew he was an asshole. Now we've got the same wars, the same lawless prisons, the same Washington corruption, but everyone is cheering like Stepford wives. It's time for a full-on hopelash."

In trying to name these various hope-related ailments, I found myself wondering what the late Studs Terkel would have said about our collective hopeover. He surely would have urged us not to give in to despair. I reached for one of his last books, Hope Dies Last. I didn't have to read long. The book opens with the words: "Hope has never trickled down. It has always sprung up." And that pretty much says it all. Hope was a fine slogan when rooting for a long-shot presidential candidate. But as a posture toward the president of the most powerful nation on earth, it is dangerously deferential. The task as we move forward (as Obama likes to say) is not to abandon hope but to find more appropriate homes for it-in the factories, neighborhoods and schools where tactics like sit-ins, squats and occupations are seeing a resurgence.

Political scientist Sam Gindin wrote recently that the labor movement can do more than protect the status quo. It can demand, for instance, that shuttered auto plants be converted into green-future factories, capable of producing mass-transit vehicles and technology for a renewable energy system. "Being realistic means taking hopeout of speeches," he wrote, "and putting it in the hands of workers." Which brings me to the final entry in the lexicon.

Hoperoots. Sample sentence: "It's time to stop waiting for hope to be handed down, and start pushing it up, from the hoperoots."

48 comments:

I hesitate to find out what that low- fi version sounds like. Deep growling lion and tiger noises from the thicket? Not at all bad ilargi, nice to hear your sound. I had been afraid I would get some nasally prepubescent whine but was pleasantly surprised by the gruff bearded projection, quite solid!

I hope there will be a next time and when there is would you mind talking more about derivatives and maybe give examples of the how and whys that those dominoes could fall as well as what degree of redundancy or protection there is, or could be, against a fall?

I'm begging for a XM satellite radio station that covers all things doomer/"sustainable." Give me Ilargi, Sharon Astyk, Nate Hagens, Naomi Klien, Meredith Whitney, the permaculture guy. I want to hear Ilargi's sharp economic mind (you've got a great voice for radio Ilargi) followed by someone on rainwater harvesting and cistern restoration.

Ilargi received heat here for daring to critique Hudson, but that linked interview highlights some issues that I have with him. His use of history - feudal government and church characterized as public concerns to establish the dubious premise that debt is a new thing; financialization being a recent occurrence - Arrighi shows how past hegemons have turned to financialization as competition became tougher; a belief that the rentier class has only now been given free reign.

But more importantly, just his whole characterization of the crisis as criminality rather than as seeing it as part of capitalist development. It is easy to demonize, much harder to look in the mirror.

But more importantly, just his whole characterization of the crisis as criminality rather than as seeing it as part of capitalist development.Capitalism isn't a development but rather a devolution, unless you consider a mechanism for capital concentration as development. Devolution particularly because humans in prehistoric time were all rentiers. It has been slippery slope since then.

"But more importantly, just his whole characterization of the crisis as criminality rather than as seeing it as part of capitalist development. It is easy to demonize, much harder to look in the mirror."

Probably both criminality and wildly capitalistic. I can only conjecture that historic periods of mania allow sociopaths to prosper more than usual and later their excesses are seen as criminal rather than "just business".

* Funding crisis headed to US soon; Chickens come home to roost in Q3 2009* Reps and Dems alike have unbending allegiance and infantile adulation to candidates of choice; More like cheering for laundry than politics; Ein Volk, Ein Reich, Ein Waschmittel* Strong Goldman policy is entrenched* Some prefer coincidence to conspiracy* Hopebroken, Hopesick and Hopelorn* Slate animates job losses on map; Gives new definition to red states* Daily Obama Amalgam: Obama is reckless Progressives still emotionally invested in Him He confers with those who got us into this problem Obama may not make it through first term as POTUS (will the PO or the TUS fail first?) He is facilitating the looting through his b*tches* Many appreciated hearing Ilargi's voice; Now we know how to pronounce his name

I guess it would be a pipe dream to think you could do a podcast as well??? That's the first thing I thought of while listening to the interview. Very good by the way.

I know the idea of doing more work may seem ludicrous, but if you have 15 minutes a week (or every few days) to do a recording and upload it to iTunes, that's all it world take. And anything beyond that would be gravy.

I think this could also expand your audience a great deal as well. Assuming that's something you're interested in. Just an idea.

We have had only figurehead Presidents for a bit, in the sense that the government/corporate policy mesh is so tight and outsource contracting so prevalent. Even Bush2 was just a puppet. I haven't seen a leader since Wellstone.

Ilargi,Your first first venture into the big audience world of audio compares favorably to the premiere performance of Susan Boyle.

Coherence, clarity, and heartfelt honesty. Not a blab in it. I even listened to it three times over, which may be the sole point where you don't quite meet the Boyle standard (I have listened to her at least a dozen times.) A magnificent debut. Bravo! Encore!

“The fact that the bailout trajectory did not waver in the slightest while passing from the Bush to the Obama administration indicates that the bailout is not a function of who’s in political power, it is a function of something else, of some other power.

I fear that Simon Johnson has nailed it: “[The] recovery will fail unless we break the financial oligarchy that is blocking essential reform.”

By continuing on our current path, using the same people who created the mess to clean up the mess, we are wasting time, we are wasting money, and we are wasting opportunity. Worse, we are risking the very sort of public backlash that has been thankfully missing from our cultural landscape for a long, long time.”America is Being Looted

Thanks for the Chris Martenson article, America is Being Looted, So far only got through the first half (it is long) but detailed and illuminating. I think most of the people here hold Martenson in high esteem.

Despite Ilargi putting it in the realm of useless tin foil hat conjecture in his radio interview, I think Martenson builds a case that the "alumni" of Goldman Sachs have usurped the government of the USA in a fashion not seen previously.

The easiest way to lose a war is not to know you are in one. That is why it is so important for the MSM media to disparage any reference to class or class warfare.

"Despite Ilargi putting it in the realm of useless tin foil hat conjecture in his radio interview..."• That is not what I said. Not even close. Besides, I have clarified what I think on a daily basis here for at the very least months. Weird shot, Roberto Gelli.

• Chris Martenson doesn't say anything that I haven't talked about many times before here. His is a nice summary, but that's it. It's not like he discovered the wheel, and neither, for sure, has Simon Johnson.

• Simon Johnson wears an IMF hat. It's very convenient that he pops up all of a sudden and gets so much attention. I don't trust him at the far end of a ten foot pole, simply because the most effective way of silencing dissent is to appropriate it, and he's the ideal vehicle for it. Age old tactic.

• In the same vein, I'm wary of the beautification of Elizabeth Warren. Nice quotes on transparency vis a vis Jon Stewart, but did anyone else notice she didn't say one word about what she's ostensibly actually in charge of, namely TARP oversight?

When a million voices clamor for clarity, you send out one of your own to address the topic in a million words, while at the same time providing no clarity whatsoever. Look, I can say about transparency what Warren did, she doesn't know more than I do on that specific general subject. It's just opinion, nothing else, and her opinion has no more value than yours or mine. Where she does know more than me and you, TARP, she was completely silent. Or did anyone learn something about what she does, specifically, to oversee the $700 billion?

I was yelling at the TV the whole time, pleading with Stewart to ask some real questions, but he instead finished the "interview" saying he felt so much better. But why? Did he hear anything he didn't already know? If so, he should get better informed. Is it such a great event that someone paid by the government says things about transparency that you and I have known all along?

Mr. J.S. Leibowitz was well prepared for Cramer; he was not for Warren.

"Simon Johnson wears an IMF hat. It's very convenient that he pops up all of a sudden and gets so much attention. I don't trust him at the far end of a ten foot pole, simply because the most effective way of silencing dissent is to appropriate it, and he's the ideal vehicle for it. Age old tactic."

Fair point. I'm not sure if it makes your case yet, but it certainly is in the scales.

"So we have two choices -- we are going to make a big decision, probably over about the next six months. And the big decision we are going to make is going to go one way or another. We are going decide, basically, "Hey, we don't need regulation. You know, it is fine. Boom and bust, boom and bust, boom and bust, and good luck with your 401k." Or alternatively we are going to say, you know, "We are going to out with some smart regulation that is going to adapt to the fact that we have new products and what we are going to have going forward is we are going to have some stability and real prosperity for ordinary folks."

What I picked up on and that was not freakin' reassuring is Adapt to New products...WTF does that mean?? Me thinks it was the new products that started this catastrophe!!